The buyer is demanding we carry a fifteen percent seller note but wants us to subordinate our debt to their senior bank lender, which leaves us with zero leverage if things go sideways. How do we structure the subordination agreement and build financial covenants into the note so we still have early-warning operational rights?

Question

Tyler Smith · Accepted Answer

Carrying a seller note means you are acting as a bank, and banks demand protection. If a buyer insists on a seller note but demands that you subordinate your debt to their senior bank lender, you must negotiate protections to avoid being completely wiped out in a default scenario. First, negotiate a sub-debt intercreditor agreement that defines your rights relative to the senior lender. While you will be subordinated as to payment of principal, you must fight to keep your monthly interest payments active unless there is a senior payment default. Second, build tight financial covenants directly into your note. These covenants should include maintaining a minimum debt service coverage ratio and a maximum leverage ratio at the operating company level. If the buyer violates these covenants, it must trigger an immediate technical default on your note, giving you the right to step in. Third, negotiate information rights. You must receive monthly financial packages, including profit and loss statements and balance sheets, so you can track the business's health. Finally, demand an equity pledge of the operating company's stock. If the buyer defaults on your note and fails to cure it, you must have the legal right to foreclose on the equity and take back control of the business. Never hand over the keys without keeping a lock on the back door.