The buyer wants to use seller financing but is demanding a subordinating agreement that prevents us from taking action on their default if their senior cash flow leverage ratio exceeds three times EBITDA. How do we structure our default triggers to maintain leverage without violating their senior lender bank covenants?

Question

Tyler Smith · Accepted Answer

Senior lenders will always demand subordination, meaning your seller note sits junior to their debt. When a buyer asks you to subordinate your right to accelerate payments upon default, they are trying to protect their senior line of credit from being blocked. If you accept a blanket standstill clause, you lose all leverage if the buyer runs your former business into the ground. To balance senior bank covenants with your financial security, structure a carve out in your subordination agreement that allows for operational defaults without triggering financial payment acceleration. Negotiate for a limited standstill period of ninety days rather than an indefinite block. This gives you the right to assert your rights once the cure period expires. Insist on a covenant that triggers an automatic board seat or observer right if the buyer misses two consecutive payments. You can also structure the note to allow for equity conversion. If they default and cannot pay due to senior debt restrictions, your debt converts into senior preferred equity with voting rights. Using your EOS® Accountability Chart, you can draft the note to state that key leadership positions must remain filled by qualified individuals who meet GWC™ standards. If the buyer replaces your capable leaders with unqualified staff, it triggers a nonmonetary default, giving you the contractual right to step back in and stabilize operations before your capital is destroyed.