We are carrying a twenty percent seller note to close our deal, but the buyer operates with thin cash reserves. What specific affirmative covenants, financial ratios, and information rights should we demand in the note agreement to protect our principal?

Question

Tyler Smith · Accepted Answer

Carrying a seller note turns you from an owner into an unsecured lender. If the buyer mismanages the business post-close, you cannot rely on passive trust. You must hold enforceable covenants and operational transparency.

First, mandate ongoing financial reporting covenants. Require the buyer to provide unaudited monthly balance sheets, income statements, and cash flow statements within twenty days of month-end, along with annual CPA-reviewed or audited financial statements. Demand access to their quarterly budget-versus-actual variances. If the buyer runs on EOS, demand access to quarterly Scorecards and updated Accountability Charts.

Second, establish explicit financial covenants. Include a minimum Fixed Charge Coverage Ratio (FCCR) and a maximum Total Leverage Ratio. If the company fails to maintain an FCCR of at least 1.15x or 1.20x, it should trigger a covenant default.

Third, write in affirmative and negative operating covenants. The buyer must maintain adequate property, casualty, and key-person insurance. More importantly, restrict executive distributions and management fees. The buyer should not pull cash out through discretionary owner dividends, related-party management fees, or aggressive bonuses if seller note payments are past due or if cash reserves fall below an agreed liquidity threshold.

Fourth, insist on inspection rights. If payments are missed or a covenant is tripped, you must hold the contractual right to inspect company records and visit facilities upon forty-eight hours of notice.

Building these monitoring mechanisms into the note agreement ensures you identify operational decay early, giving you leverage to force corrective action before the senior lender moves to liquidate.