The buyer wants us to carry a seller note for twenty percent of the deal. If we must take this risk, how do we structure the note to include an equity warrant kicker or a pricing step-up that lets us capture upside if they recapitalize or sell?

Question

Tyler Smith · Accepted Answer

If you are forced to act as the bank, you must be compensated for taking on subordinated debt risk. A plain vanilla seller note with a low single-digit interest rate is a bad deal. You should demand equity warrants or a pricing step-up to capture the enterprise value upside your historical work made possible. Structure the seller note with a warrant kicker that grants you the right to purchase a specific percentage of the company's equity at a nominal price. If the buyer scales the business and achieves a secondary sale, your warrants convert into cash, letting you participate in the second bite of the apple. Alternatively, write a pricing step-up clause directly into the note. This clause dictates that if the company is sold, recapitalized, or undergoes a change of control before your note is fully repaid, the outstanding principal automatically increases by a set premium, such as twenty percent. Additionally, negotiate a PIK interest feature. Payment-in-kind interest allows the interest to accrue and compound into the principal balance, increasing your ultimate payout while preserving the company's operating cash flow. These mechanisms ensure that if the buyer uses your capital to generate massive returns, you are rewarded as an investor, not just a lender.