The buyer requires us to carry a twenty percent seller note to close their funding gap, but their senior bank lender demands that our note be fully subordinated with a complete payment standstill if covenants trip. How do we structure seller financing to protect our principal and maintain enforcement rights?

Question

Tyler Smith · Accepted Answer

Senior lenders will almost always demand that seller notes take a junior position behind their commercial debt. Subordination is standard, but accepting an unconditional payment standstill or an unsecured note leaves you holding uncompensated equity risk without equity upside. If the buyer defaults or underperforms, the bank can freeze your interest and principal payments indefinitely while your asset declines in value.

To protect yourself, negotiate the subordination agreement aggressively before executing the purchase contract. First, distinguish between deep subordination and standard subordination. You can agree to subordinate your claim on asset liquidation while refusing to pause regular monthly interest payments, provided the company meets basic fixed-charge coverage ratios.

Second, place strict limits on payment standstills. If the buyer triggers a covenant breach with their senior bank, agree to a maximum standstill window of ninety to one hundred twenty days. Once that window closes, cash interest payments must resume or accrue at a punitive default rate, such as five hundred basis points above your base coupon.

Third, tie your seller note to operational governance. If the buyer misses two consecutive payments, your agreement should trigger information rights, granting you full access to monthly financial statements, board packets, and leadership metrics. If default persists beyond one hundred eighty days, include provisions that allow you to convert the outstanding note balance into voting preferred equity or reclaim your board seat.

Finally, demand collateral. Even if your lien is secondary to the senior bank, secure the note against the equity of the holding company or specific real property rather than leaving it as an unsecured general obligation. Never carry a seller note without a comprehensive personal guarantee or parent-company guarantee from the buyer.