We are providing seller financing to an acquisition-specific LLC formed by a buyer with no standalone assets. What guarantees and collateral covenants do we need so our note is backed by real value?

Question

Tyler Smith · Accepted Answer

Never accept a promissory note issued exclusively by a newly formed acquisition holding company or shell entity. If the business encounters financial distress, senior lenders will seize operating assets, leaving your subordinated seller note stranded against an empty corporate shell with zero recoverable value.

To establish real security for your seller note, insist on three distinct layers of collateral protection:

- Parent Entity Guarantee: Require the ultimate parent company or private equity fund sponsor to execute an absolute, unconditional corporate guarantee covering note principal and interest. If the sponsor uses a special purpose vehicle to complete the transaction, the operating company and fund entity must be held jointly and severally liable.
- Pledge of Equity Interests: Secure a formal equity pledge agreement granting you a perfected security interest in one hundred percent of the operating company's capital stock or LLC membership units. In the event of an uncured payment default on the seller note, this pledge provides an expedited legal pathway to foreclose on the equity and repossess the operating company.
- Cross-Default and Standstill Limitations: Your seller note must contain an express cross-default clause stating that any material default under senior bank financing constitutes an immediate default under your note. Furthermore, while the senior lender will demand a standstill period preventing legal action, negotiate that standstill down to a maximum of ninety to one hundred twenty days. After that window expires, your remedies must fully activate.