We are structuring our exit as an installment sale under Section 453, but the buyer wants to secure the seller note solely against our company assets which they plan to leverage with senior bank debt. How do we structure the default covenants to protect our position?

Question

Tyler Smith · Accepted Answer

Pledging the assets of the sold business as the sole collateral for an installment note under IRC Section 453 is highly risky, especially when a buyer is layering senior bank debt on top of those same assets. If the buyer defaults, the senior lender will seize the assets, leaving you with a worthless junior claim. To protect your note, you must structure a multi-layered security package.

First, secure a personal guarantee from the buyer's principal owners or parent entity, rather than just the operating business. This ensures they have personal skin in the game. Second, demand a share pledge agreement that gives you a security interest in the equity of the company itself. In the event of a default, this allows you to foreclose on the stock and regain operational control of the business.

Third, write strict financial and operational covenants into the note. Establish clear thresholds for debt-service coverage ratios and leverage ratios. Track these metrics monthly. If the buyer fails to meet these thresholds, it must trigger a technical default, giving you the right to intervene before the business completely deteriorates.

Align these protections with your EOS operating data. Require the buyer to provide you with their monthly financial statements and key scorecard metrics. By monitoring their operational health, you can spot early warning signs of distress and take legal action to protect your principal before the senior lender declares a default.