The senior lender requires our seller note to be fully subordinated with a complete payment standstill if the buyer violates their senior debt covenants. How do we structure seller financing to protect our cash flow and ensure we get paid?

Question

Tyler Smith · Accepted Answer

Senior lenders will not finance a leveraged acquisition unless any seller debt is subordinate to their credit facility. However, a blanket subordination agreement that gives the bank unlimited standstill rights effectively turns your seller note into equity without equity upside. You must negotiate a clear distinction between deep subordination and standard structural subordination.

Insist that scheduled interest and principal payments on your seller note continue uninterrupted as long as there is no senior payment default. Banks will push for broad language allowing them to stop your payments for non-financial or technical covenant breaches, such as reporting delays. Limit payment blockage to two events: an actual monetary default on senior debt service or an uncured leverage ratio breach.

Second, cap any payment standstill period at ninety to one hundred twenty days, and allow only one standstill period within any twelve-month rolling window. Once that period expires, if the bank has not accelerated its debt or foreclosed on the business, your payments must resume, including all unpaid amounts.

Third, ensure that blocked payments accrue compound interest at a designated default rate, typically three to five percent above the base note rate, or convert into payment-in-kind notes that expand your principal balance. Finally, require immediate notice of any senior default and the right to cure senior payment defaults on behalf of the buyer to protect your position before the bank initiates a fire-sale liquidation.