The buyer is demanding a seller note to bridge their funding gap, but we are worried that inflation will erode the value of our payments or that they will refinance and pay us off early at a discount. How do we structure interest rate indexing and prepayment premiums to protect our yield?

Question

Tyler Smith · Accepted Answer

Accepting a seller note means you are acting as a bank, and you must protect your capital with the same rigor a bank would. If the buyer pays off the note early, you lose the expected interest yield. If inflation spikes, your fixed return is eroded. You must build specific protections into the promissory note to defend your long term return.

First, address the inflation risk by indexing the interest rate. Instead of a fixed rate, peg the interest rate to a floating benchmark like the Prime Rate or Secured Overnight Financing Rate plus a specified spread. To prevent downside risk, establish an interest rate floor that guarantees a minimum acceptable return regardless of market fluctuations.

Second, eliminate the risk of an unwanted early payoff by negotiating a prepayment premium. You can structure this as a yield maintenance clause or a declining prepayment penalty schedule:

- A common structure is a five percent penalty if paid in year one, descending by one percent each year thereafter.
- Alternatively, require a lock out period during which the buyer cannot prepay the note at all.

During your weekly Level 10 Meeting™, your leadership team should monitor these financial terms as key scorecard metrics. Treating the seller note as a strategic asset rather than a deal concession ensures you preserve the full enterprise value you worked so hard to build.