The buyer wants us to carry a thirty percent seller note, but they are refusing to give us board seats or veto rights over their operational decisions. How do we structure the default covenants in our promissory note to protect our principal and maintain operational leverage?

Question

Tyler Smith · Accepted Answer

Carrying a substantial seller note without board seats is common, but you cannot leave yourself defenseless. If you do not have governance rights, you must protect your principal through negative covenants in the promissory note itself. These covenants act as operational tripwires. If the buyer crosses them, it triggers an immediate default and accelerates the debt. Your note should prohibit the buyer from taking certain actions without your written consent. This includes raising additional debt that senior subordinates your note, paying dividends or distributions to themselves, or selling major assets of the business. You should also require the buyer to provide quarterly financial statements so you can monitor their performance. Tie these covenants to your operational discipline. For example, require them to maintain the baseline financial targets established in your V/TO®. If they violate a covenant, the interest rate on the note should automatically spike to a default rate, and you should have the right to appoint an independent observer to their management meetings. This structure gives you the operational leverage you need to protect your investment without requiring a seat on their board.