We are accepting a seller note, but we want to prevent the buyer from strip-mining our company's cash to pay their parent company. What specific financial covenants or Level 10 Meeting oversight can we build into the note to protect our position?

Question

Tyler Smith · Accepted Answer

When you accept a seller note, you become a creditor of the business you used to own. If a buyer behaves recklessly, they can starve the business of working capital or bleed its cash reserves to fund their parent company, leaving your note unpaid.

To protect your capital, you must build strict financial and operational covenants directly into the promissory note. First, establish a maximum leverage ratio and a minimum debt-service coverage ratio. This ensures the business must maintain a healthy buffer of cash flow relative to its debt obligations before making any distributions to the parent company.

Second, include a strict restriction on affiliate transactions. This prevents the buyer from paying massive management fees, consulting fees, or overhead allocations to their parent company or sister entities unless your seller note is current and the business meets its financial targets.

Additionally, secure observer rights on the board or require them to provide you with monthly financial packages, including their balance sheet and cash flow statements. This acts as your operational early warning system. If key financial metrics begin to slide, you will know immediately, allowing you to invoke default remedies before the business is completely hollowed out. Do not leave your financial future to the buyer's goodwill; lock in these protective guardrails to keep your money safe.