The buyer wants us to carry a five-year seller note with zero principal amortization and a balloon payment at maturity, but refuses to include a mandatory prepayment trigger if they recapitalize or sell the business. How do we protect our principal?

Question

Tyler Smith · Accepted Answer

Accepting an unamortized balloon note without a change-of-control acceleration clause leaves you fully exposed to the buyer trading away your recovery. If they refinance, take out dividend recapitalizations, or sell the platform, new senior debt will subordinate your position further while cash flows exit the business. You must make liquidity events trigger immediate repayment.

First, make change of control an absolute default and acceleration event. If the company sells more than fifty percent of its voting stock, sells substantially all operating assets, or completes an equity recapitalization, the note balance must accelerate and become payable prior to or concurrent with distributions to the equity holders.

Second, demand mandatory partial prepayments tied to excess cash flow sweeps. If the company hits specific performance milestones or generates surplus operating cash flow above senior debt service, a percentage of that cash must pay down your principal balance before equity distributions or sponsor management fees occur.

Third, introduce an escalating coupon if the note is not refinanced on schedule. For example, if the note carries an eight percent interest rate in years one through three, escalate the rate to twelve percent in year four and fourteen percent in year five. This financial penalty forces the buyer to prioritize refinancing your note through their senior lender.

Structure the seller note as patient capital for operations, not an interest-free insurance policy for the buyer. If the buyer plans to build enterprise value and exit, they must agree that your capital gets paid before they take their profits.