The buyer wants us to carry a seller note for thirty percent of the purchase price, but they want it subordinated to their senior bank debt and junior mezzanine lenders. How do we protect our position as a junior creditor without killing the deal?

Question

Tyler Smith · Accepted Answer

Subordination is standard in mid-market transactions, but being pushed behind both a senior bank and a mezzanine lender puts your capital in high jeopardy. If the company hits a cash crunch, those senior lenders can freeze your payments under a standstill agreement. To protect your seller note, you must negotiate the specific terms of the intercreditor agreement rather than fighting the subordination itself.

Start by capping the senior lender's standstill period. A standard bank will want an indefinite freeze on your payments if the buyer defaults. Negotiate a hard limit of ninety to one hundred twenty days. If the buyer is still in default after that period, your right to receive interest payments must automatically resume.

Next, negotiate block rights on structural changes. The buyer should not be allowed to take on additional senior debt, pay distributions to equity holders, or increase executive compensation while your note is outstanding. Use the Trust Equation to present these demands as standard risk-management practices rather than a lack of faith in the buyer's capabilities.

Finally, tie the seller note to an equity conversion feature. If the buyer defaults and cannot pay, your note should allow you to convert the outstanding balance into preferred equity or reclaim operational control of the board. This ensures that if the business struggles, you have a clear path to step back in and protect the enterprise value before the senior lenders foreclose on the assets.