The bank funding our buyer's acquisition wants us to sign a subordination agreement that blocks any seller note payments if the company breaches a senior debt covenant. How do we negotiate carve-outs or acceleration clauses in our seller financing agreement so we do not get completely wiped out?

Question

Tyler Smith · Accepted Answer

When you agree to seller financing, the buyer's senior lender will always demand priority. They want a subordination agreement that prevents you from collecting payments if the business struggles. If you sign a standard, unrestricted subordination agreement, you risk having your cash flow cut off over a technical covenant breach that has nothing to do with your note. You must fight for specific carve-outs to protect your position.

First, negotiate a standstill period. This prevents the senior lender from blocking your payments indefinitely. Demand that any block on your seller note payments is limited to a maximum of 120 or 180 days in any consecutive twelve-month period. Once that window expires, the buyer must resume paying you unless the senior lender has declared a formal default and accelerated their own debt.

Second, define what constitutes a payment block. Do not allow a minor reporting covenant breach, like a late financial statement, to halt your payments. Limit payment blocks strictly to payment defaults on the senior loan or major financial covenant breaches, like debt service coverage ratio failures.

Third, build in a right to convert your unpaid debt into equity or operational control if the default continues past the standstill window. In your quarterly planning, use the IDS® process to evaluate the buyer's operational health. If you notice signs of stress, prepare your legal counsel to issue default notices immediately. This keeps you from being passive bystanders while the senior lender takes over the company you built.