The buyer wants us to carry a junior seller note for twenty percent of the transaction, but we want some upside if they scale the business using our proprietary systems. How do we structure warrants or a debt-to-equity conversion option in the seller note to capture this post-close growth?

Question

Tyler Smith · Accepted Answer

If a buyer expects you to carry a twenty percent junior seller note, you should demand upside in exchange for the risk you are taking. You can structure this by adding a warrant kicker or a debt-to-equity conversion option to the note. This allows you to convert a portion of the unpaid debt into equity if the business hits specific scaling milestones.

First, define the conversion terms based on a clear valuation methodology. Use an Income Approach under IVS 105 to establish a pre-negotiated valuation formula for the conversion. If the business reaches a certain EBITDA threshold, you have the right to convert a portion of your remaining seller note into equity at a predetermined multiple.

Second, structure the warrants to trigger upon specific milestones or a subsequent liquidity event. The warrants should grant you the right to purchase a fixed percentage of the buyer's holding company at a nominal price. This ensures that if the strategic buyer uses your systems to double the business, you participate in that value creation.

Third, protect this potential equity. Ensure the note agreement includes anti-dilution provisions and drag-along rights. If the buyer recapitalizes or sells the business, your warrants or converted equity must be protected from being wiped out. This turns a standard, risky seller note into a high-yielding, strategic investment in the future of the company.