The buyer wants to subordination-link our seller note to their senior bank debt, which would block our payments if they breach their bank covenants. How do we structure subordination terms to protect our cash flow from their bank performance?

Question

Tyler Smith · Accepted Answer

Senior lenders will always demand that a seller note be subordinated to their acquisition debt. However, accepting a standard, blanket subordination agreement puts your cash flow at severe risk if the buyer mismanages the company post-close. You must negotiate specific guardrails into the subordination agreement to protect your payments. First, insist on a carve-out that allows for block-free payments of regular principal and interest as long as no senior default has occurred. The bank should not be allowed to block your payments simply because the buyer is close to a financial covenant threshold. There must be an actual, declared event of default under the senior credit agreement before your payments are suspended. Second, negotiate a payment blockage window. If the senior lender does trigger a payment blockage, limit that interruption to a maximum of ninety or one hundred and eighty days. Once that period expires, the buyer must resume payments to you unless the senior lender has initiated formal foreclosure proceedings on the company's assets. Finally, ensure that any blocked interest continues to accrue and compound at a higher default rate. This penalizes the buyer for senior breaches and rewards you for the delayed cash flow. Run these scenarios through your strategic planning sessions to ensure your financial health can withstand a temporary pause in payments.