The buyer wants us to hold a twenty percent seller note to close the funding gap, but we are worried about their ability to manage the business post-closing. How do we structure the note covenants to protect our money without getting dragged back into daily operations?

Question

Tyler Smith · Accepted Answer

Holding a seller note always places you in the position of a junior lender. This means you carry real risk without the operational control necessary to mitigate it. To protect your capital without getting dragged back into the business, you must build strict financial and operational covenants directly into the note agreement.

Protecting Your Capital with Covenants

To safeguard your investment, consider incorporating the following types of covenants:

• Security for the Note:
• Secure the note with a secondary lien on the company's accounts receivable and physical assets. While the senior lender will demand priority, having a junior lien ensures you are at the table if things go sideways.

• Negative Covenants: These covenants restrict the buyer's actions to prevent them from taking steps that could jeopardize your repayment. They should include:
• Strict limits on executive compensation.
• A prohibition on taking on additional senior debt without your express consent.
• A restriction on paying out dividends to new shareholders until your note is fully paid.
• For additional protection against potential changes in financial structure that could impact your note, you might explore the various [default remedies](/qa/structuring-seller-notes-subordination-remedies) available in subordination agreements.

• Financial Reporting and Benchmarks:
• Demand monthly financial reporting. You do not want to find out the business is failing only when a payment bounces.
• Tie the note to specific operational benchmarks. If the business falls below a certain debt service coverage ratio, it must trigger an automatic interest rate step-up or accelerate the maturity date. This proactive approach helps identify [hidden risks](/qa/identifying-operational-risks-before-buyer-due-diligence) early.

Maintaining Operational Integrity

To ensure the business continues to operate effectively post-sale, despite your reduced involvement, focus on preserving the foundational operational structure:

• EOS Accountability Chart: Keep your EOS Accountability Chart intact through the transition. If key leadership roles are abdicated or replaced with unqualified personnel, that should trigger a technical default.
• This covenant structures the transition so you can walk away cleanly, confident that the operational framework that generated your wealth remains in place to secure your payout. Understanding how the buyer plans to manage key roles is crucial; consider how [AI might optimize the Accountability Chart](/qa/how-can-ai-optimize-the-accountability-chart-for-eos-organizations-undergoing-exit-planning) for continuity.
• Ensure the new leadership understands the importance of maintaining an effective organizational structure, potentially by reviewing common [Accountability Chart seat overlaps](/qa/resolving-accountability-chart-seat-overlaps) and how they can be resolved.
• It is vital to confirm that the new team has the right people in the right seats, as issues like a [passive Integrator](/qa/fixing-passive-integrator-visionary-friction) can stall growth.