The buyer is pushing for a substantial seller note to bridge our valuation gap but refuses to grant us any corporate governance rights. How do we structure negative covenants in the note to prevent them from taking on excessive senior debt or selling off key assets before we are paid in full?

Question

Tyler Smith · Accepted Answer

Accepting a seller note means you are acting as a junior lender. Without proper protections, a buyer can easily leverage the company, prioritize their own distributions, and leave you holding an uncollectible piece of paper. To protect your position, you must negotiate strict negative covenants directly within the note or the purchase agreement. First, demand a limitation on senior debt. The buyer should not be allowed to incur senior bank debt beyond a specific leverage ratio, such as two times EBITDA, without your written consent. Second, require covenants that restrict the buyer from making discretionary distributions, paying management fees to their equity sponsors, or raising executive salaries until your note is paid. Third, prohibit the sale, lease, or transfer of any material corporate assets outside the ordinary course of business. These restrictions keep the operational cash flow focused on debt service. From an operational standpoint, you can monitor compliance by requiring monthly financial packages, identical to the ones your leadership team reviews in their monthly meetings. If they violate a covenant, it must trigger an immediate event of default, accelerating the note and increasing the interest rate to a penalty level. This keeps the buyer honest and ensures they respect your position as a key stakeholder.