The buyer is insisting on a seller note representing fifteen percent of the purchase price, but their private equity sponsor is bringing in a senior lender who wants us to sign a standard, highly restrictive subordination agreement. How do we negotiate specific carving-out exceptions in the subordination agreement so we do not lose our monthly interest payments if the buyer merely misses a non-financial reporting deadline?

Question

Tyler Smith · Accepted Answer

When a private equity buyer brings in senior debt, the senior lender will require you to sign a subordination agreement. This document dictates your rights as a junior creditor. The bank's standard agreement will try to cut off your monthly interest and principal payments if the buyer triggers any covenant default, even a minor administrative one like submitting financial statements late. You must fight this asymmetrical structure during the letter of intent stage. Negotiate for a clear distinction between a payment default on senior debt and a mere covenant default. Your subordination agreement should state that payments on your seller note can only be blocked if there is an active payment default on the senior loan or if a bankruptcy proceeding is underway. Furthermore, demand a limited payment blockage period. This clause ensures that even if the senior lender blocks your payments due to a covenant default, they can only do so for a maximum of ninety to one hundred and twenty days. Once that window closes, payments to you must resume unless the bank has accelerated their loan. To protect your interests, make sure your credit agreement includes operational covenants. Use your historical metrics to set clear financial boundaries. If the buyer's leverage ratio exceeds a certain multiplier, your interest rate should automatically step up to compensate you for the increased risk. This keeps the buyer honest and ensures you are treated as a serious capital partner, not a soft target.