We agreed to provide a 20 percent seller note to help an independent sponsor finance the acquisition, but their senior bank will not allow us to hold a secondary lien on company assets. How do we secure and protect our seller note without asset collateral, and what enforcement mechanisms or equity pledge structures should we demand?

Question

Tyler Smith · Accepted Answer

Commercial senior lenders will almost never allow a seller to hold a second mortgage or junior lien on company accounts receivable, intellectual property, or physical assets. If you agree to an unsecured seller note without alternative collateral, you are operating as an uncompensated junior equity holder without any equity upside.

To protect your principal when the bank blocks an asset lien, demand a pledge of the equity interests in the acquisition entity. In this structure, the sponsor pledges 100 percent of the equity shares of the buyer holding company as collateral for your seller note. If the buyer defaults on their debt obligations to you, you do not seize operating assets in violation of bank liens; instead, you foreclose on the buyer equity and regain ownership of the company itself.

Next, negotiate a spring board seat or board observation rights that activate upon any missed interest or principal payment. This ensures you maintain visibility into the financial Scorecard and operational health of the company before it enters insolvency.

Require strict financial covenants matching the senior lender ratios, such as a minimum debt service coverage ratio and limitations on owner distributions. If the buyer strips cash out of the business to pay management fees while deferring your note, it triggers an immediate default event.

Finally, secure a personal guarantee from the individual principals of the sponsor or parent company where permissible. If the buyer refuses both an equity pledge and basic financial covenants, increase the interest coupon significantly or demand payment-in-kind warrants to compensate for your junior, unsecured risk profile.