A prospective buyer wants us to carry a seller note for 30 percent of the purchase price but refuses to provide a personal guarantee because they are acquiring us through a special purpose LLC. What structural covenants and security terms should we demand in the note to protect our capital?

Question

Tyler Smith · Accepted Answer

Accepting an unbacked seller note from a special purpose LLC turns you into an unsecured lender taking equity risk without equity upside. If a personal guarantee is unavailable, you must secure your note with institutional-grade corporate covenants and asset-level protections.

First, require an equity pledge agreement. The buyer's parent entity must pledge 100 percent of the acquired operating company stock or membership units as collateral for the seller note. If the buyer defaults on scheduled principal or interest payments, this pledge allows you to exercise voting proxy, remove their leadership, and repossess the company without navigating prolonged bankruptcy litigation.

Second, institute financial maintenance covenants. Establish a mandatory Debt Service Coverage Ratio of at least 1.25x and set a strict ceiling on total funded leverage. Require quarterly financial delivery certified by an independent accountant within 45 days of quarter-end. If the buyer breaches these ratios, insert a covenant that automatically raises the note interest rate by 400 basis points and freezes all executive bonuses or profit distributions.

Third, secure negative operating covenants. The note agreement must legally prohibit the buyer from making dividend distributions, incurring additional debt senior to your note, increasing management fees, or selling material business assets while your note remains unpaid.

If the buyer refuses both personal guarantees and restrictive covenants, you are subsidizing their transaction with unhedged risk. Stand firm on protective loan covenants or require third-party senior debt to fund that portion in cash at close.