We agreed to provide a $2 million seller note to bridge a valuation gap, but the senior lender prohibits us from taking a second lien on company assets. How do we secure our seller financing without violating the senior bank covenants or exposing ourselves to total default risk?

Question

Tyler Smith · Accepted Answer

When a senior bank finances an acquisition, they mandate absolute priority on corporate collateral and routinely block second-lien positions on operating assets. Carrying an unsecured seller note without collateral leaves you completely exposed if the buyer stumbles or runs into liquidity trouble.

You cannot challenge the senior lender on asset liens, so you must secure collateral outside the commercial bank security package. The primary mechanism is a pledge of buyer equity. Require the holding company or acquisition vehicle to pledge one hundred percent of the target company equity shares into an escrow account held by an independent collateral agent. If the buyer defaults on the seller note, you hold the legal right to foreclose on the shares and reclaim ownership of the business, subject to senior debt covenants.

Next, demand a joint and several personal guarantee from the private equity sponsors or individual principals backing the transaction, carve-out guarantees for bad acts, and springing covenants. Springing covenants establish that if the buyer maintains a defined debt service coverage ratio, payments continue unobstructed, but if coverage drops, excess cash flow sweeps automatically into an escrow account to fund your note.

Finally, establish strict information rights. You must receive monthly financial statements, borrowing base certificates, and senior debt compliance letters within thirty days of each month-end. You need early warning signs long before a technical default occurs so you can bring issues to the table and protect your capital before enterprise value deteriorates.