The buyer is asking us to carry a twenty percent seller note to close our funding gap, but we want to make sure this debt does not become worthless if they pivot the business. How do we structure a negative covenant package in our seller financing agreement to protect our position, and how do we monitor it?

Question

Tyler Smith · Accepted Answer

When you agree to carry a seller note, you are essentially acting as a junior lender, which means you bear substantial risk with very little control. To protect your note from a buyer who might pivot the business into a risky new market, you must negotiate a robust negative covenant package.

These negative covenants are legally binding restrictions in your seller financing agreement that prevent the buyer from taking specific high-risk actions without your prior written consent.

First, restrict their ability to incur additional senior debt or subordinate debt beyond a predetermined limit. This prevents them from overleveraging the company and pushing your note further down the repayment priority list.

Second, prohibit major changes in the business model. For example, specify that they cannot pivot from your core service offering to an untested market or sell off major operating assets that generate the cash flow required to service your debt.

Third, place strict limits on distributions, dividends, and owner compensation. The buyer should not be draining cash from the business to pay themselves or their investors while your note remains unpaid.

To monitor compliance, require them to provide quarterly financial statements. If they violate any of these restrictions, it must constitute an immediate event of default, allowing you to accelerate the loan or trigger operational remedies using the existing Accountability Chart to protect your capital.