A buyer offers an 8x multiple on paper but demands we finance 30 percent of the purchase price via an unsecured five-year seller note. How do we stress-test whether carrying this paper is worth the headline valuation?

Question

Tyler Smith · Accepted Answer

A high headline valuation multiple means nothing if thirty percent of your purchase price is locked in illiquid, subordinate paper that default risk could wipe out. Buyers frequently use seller financing to stretch their nominal multiple without deploying additional equity or drawing expensive senior debt. To determine if the paper is worth holding, you must discount the note to its actual risk-adjusted present value.

Start by evaluating the buyer's post-closing capital stack. If the buyer is funding forty to fifty percent of the transaction with senior bank loans, that bank will demand senior security interests and require you to sign a subordination agreement. Under standard intercreditor terms, your seller note is blocked from receiving cash payments if the buyer trips senior debt service coverage covenants. You must model the combined company cash flow assuming a twenty percent drop in post-close revenue. If their debt service coverage ratio falls below 1.25x under stressed conditions, your note payments will be frozen.

Next, insist on structural protections that convert paper promises into genuine debt security. Demand an interest rate that accurately reflects subordinated mezzanine risk, typically twelve to fifteen percent, with a cash-pay component plus payment-in-kind interest. Secure personal guarantees from the sponsor principals if dealing with an individual search fund, or require cross-corporate guarantees across all operating subsidiaries.

Finally, compare the net present value of this 8x leveraged package against a clean 6x all-cash or senior-secured alternative. If the unsecured paper yields a realistic post-tax net recovery comparable to an all-cash exit at a lower multiple, you are taking private equity risk without equity upside. Do not accept unsecured debt merely to satisfy an ego-driven headline multiple.