The buyer wants us to provide a 20 percent seller financing note to complete their debt stack, but we are worried about their ability to manage the business post-sale. What specific operational oversight rights, financial covenants, and default triggers should we insist on to protect our capital?

Question

Tyler Smith · Accepted Answer

Carrying a seller note means you are no longer just an ex-owner; you are an uncollateralized or junior lender with capital at risk. If the buyer mismanages cash flow or destroys core operations, your note will be the first instrument they stop paying. To mitigate this risk, you must demand institutional-grade covenants in the subordinated loan agreement.

Start with strict operational covenants. Require the buyer to deliver monthly financial statements, balance sheets, and cash flow reports within twenty days of month-end, along with annual reviewed or audited GAAP financials. You need ongoing visibility into cash burn and margin health rather than waiting for an annual summary. If the business ran on EOS®, push for continuing access to their high-level leadership Scorecard metrics. You want to spot operational deterioration long before it shows up as a balance sheet default.

Next, establish rigid financial guardrails. Mandate a minimum fixed-charge coverage ratio and a maximum senior leverage ratio. If the business falls below those thresholds, the buyer must be prohibited from paying owner distributions, management fees, or executive bonuses until your note payments are current and financial ratios normalize.

Finally, build in definitive default triggers. Standard provisions should include a change-of-control default, failure to maintain commercial insurance, cross-defaults on senior commercial bank debt, and an acceleration clause. If an uncured default occurs, your interest rate should immediately increase to a punitive default rate of at least five hundred basis points above the base rate. You must also reserve the right to appoint a board observer or regain board seats to oversee an operational turnaround if senior debt covenants are breached.