The buyer is offering a strong headline purchase price but insists on a twenty percent seller note, while their senior bank lender demands full subordination and standstill terms. How do we structure protective covenants so our seller note actually gets paid?

Question

Tyler Smith · Accepted Answer

A seller note is not just delayed purchase price; it is uncollateralized risk unless structured with precise contractual protections. Buyers frequently use seller notes to bridge valuation expectations, but when their senior lender enforces a complete standstill agreement, you lose the ability to collect payments if the business hits a bump in the road.

To protect your capital, negotiate the intercreditor agreement directly. Insist on a fish-or-cut-bait provision regarding standstills. While the bank will require payment subordination during an active senior loan default, cap any standstill period at ninety to one hundred and twenty days. After that period, if the senior lender has not accelerated their debt or foreclosed, your note payments must resume.

Second, demand a market interest rate that reflects your subordinated risk profile, typically eight to twelve percent, with a payment-in-kind toggle if cash flow covenants are temporarily breached. Require that interest accrues and compounds monthly rather than sitting dormant.

Third, secure negative covenants in the purchase agreement. Prohibit the buyer from taking management fees, making equity distributions to sponsors, or taking on additional subordinated debt while your note is outstanding.

Finally, tie seller note protections to operational visibility. Demand quarterly financial statements and the right to inspect the books until the note is retired. If the buyer is unwilling to accept reasonable limits on the senior lender standstill or insists on subordinating your right to repayment behind sponsor fees, reduce the size of the note and demand cash at closing.