The buyer is asking us to carry a seller note for thirty percent of the purchase price but wants it subordinated to their senior lender and expects a payment in kind interest structure. How do we negotiate the protective covenants of this note to minimize our risk of non-payment?

Question

Tyler Smith · Accepted Answer

Carrying thirty percent of your enterprise value in a seller note is a major risk, especially when subordinated to a senior bank. To protect your position, you must negotiate strict operational and financial guardrails before signing the definitive agreements. First, insist on a default rate bump of at least five hundred basis points if the buyer misses a payment. Next, negotiate block rights on key corporate actions. The buyer should not be allowed to raise additional debt, pay equity distributions to sponsors, or execute major acquisitions without your written consent while your note remains unpaid. To address the payment in kind or PIK structure, negotiate a hard transition date where PIK interest must convert to cash payments within twelve to eighteen months. You should also tie the note to the company Scorecard metrics. Demand monthly financial statements and quarterly compliance certificates to monitor their debt service coverage ratio. If they breach these covenants, you must have the right to attend their board meetings or install an independent observer. This keeps the buyer honest and ensures you are not flying blind. Use your weekly Level 10 Meeting to keep your own leadership team focused on delivering a clean operational handoff, which remains the best mitigation strategy against post-close performance drops that trigger a debt default.