We are accepting a significant seller note, but we want to ensure the buyer does not starve the business of working capital to pay themselves dividends first. How do we use financial covenants and restricted payment clauses to protect our seller note?

Question

Tyler Smith · Accepted Answer

Accepting a seller note means you are acting as a bank, and you must protect your position exactly as an institutional lender would. To prevent the buyer from draining the company's cash through dividends or management fees before your note is repaid, you must write tight financial covenants into the subordinated loan agreement.

Ensure you negotiate the following core protections:
- A restricted payments covenant that explicitly prohibits the buyer from making any distributions, dividends, or parent-company allocation payments as long as the seller note is outstanding.
- A minimum net working capital covenant based on your historical EOS® scorecard data to define the baseline liquidity required to run the business.
- A strict cap on the management fees the buyer can charge the operating entity, keeping them at a low, fixed annual dollar amount to prevent them from stripping out EBITDA.

By placing these guardrails around the cash flow, you ensure the company maintains the liquidity required to service your debt first.