The buyer's bank will not allow us to place a second lien on the business assets to secure our seller note. What alternative security mechanisms can we negotiate to ensure we can take back the company if the buyer defaults?

Question

Tyler Smith · Accepted Answer

When senior lenders enforce strict negative covenants barring junior liens on company assets, you must pivot to structural and corporate governance security rather than asset liens. The most effective mechanism is a pledge of equity interests. Under this structure, the buyer pledges one hundred percent of the equity in the operating company into an escrow account held by an independent agent. If the buyer defaults on your seller note and fails to cure the default within the agreed window, ownership voting rights revert to you immediately, allowing you to remove the buyer from the board and seize operational control without competing against the senior lender in bankruptcy court.

Pair this equity pledge with negative covenants written directly into the note purchase agreement. These covenants should prohibit the buyer from taking distributions, issuing executive bonuses, selling major business assets, or taking on additional subordinated indebtedness while your note is outstanding. Require them to provide quarterly compliance certificates and monthly financial statements so you can track liquidity in real time.

Additionally, negotiate a personal guarantee from the buyer or the private equity fund general partner, even if it is capped at the principal balance of the note. Senior lenders rarely object to personal guarantees because they do not threaten bank collateral. If the buyer refuses a personal guarantee and equity pledge, they are asking you to take equity risk without equity upside. Do not finance their acquisition without a clean path to reclaim the operating asset if they break the company.