The buyer's senior lender is demanding that our seller note be fully subordinated, meaning we get nothing if things go south and cannot even collect interest payments if the buyer breaches their bank covenants. How do we negotiate subordination terms that protect our cash flow?

Question

Tyler Smith · Accepted Answer

Subordination is standard in transactions involving senior bank debt, but full subordination that cuts off your interest payments is a massive risk. You must negotiate a fair subordination agreement, often called a subordination and standstill agreement, that balances the bank's security with your right to be paid. First, insist on a block-payment carve-out. This clause ensures that you continue to receive your regularly scheduled interest and principal payments as long as the buyer is in compliance with their senior bank covenants. Second, limit the standstill period. If the buyer does default, the senior bank will want to freeze your payments indefinitely. You should negotiate a maximum standstill period of ninety to one hundred and eighty days, after which you regain the right to pursue collection actions or foreclose on your junior collateral. Third, ensure that any payment default by the buyer on your seller note continues to accrue interest, and that this interest compounds until paid. Within your leadership team, use your Level 10 Meetings to run scenario plans on different covenant levels. Understand the buyer's projected debt service coverage ratio post-close so you can assess the likelihood of a covenant breach. By demanding these protective carve-outs, you ensure your seller note remains a viable, cash-flowing instrument rather than a paper write-off.