How do we structure the interest rate and payment terms on our seller note to make sure we are beating inflation and have real recourse if the buyer defaults, without breaking their bank debt covenants?

Question

Tyler Smith · Accepted Answer

Carrying a seller note is often necessary to get a deal done, but you cannot let the buyer use your money for free or treat you like a soft lender. To protect yourself, structure your seller note with a compounding interest rate that sits at least three to four hundred basis points above the prevailing prime rate. This ensures your capital keeps pace with inflation and rewards you for taking subordinate risk. Insist on a monthly amortization schedule rather than a balloon payment at the end of five years. This gets your principal out of the business gradually.

To handle the senior bank covenants, agree to subordinate your payment rights only to the extent that a formal default has occurred on the senior debt. Do not agree to a blanket standby provision that halts your payments from day one. Instead, write in a block period limit of ninety days. If the buyer defaults on their senior loan, your payments can only be paused for those ninety days before the bank must either foreclose or allow your payments to resume.

Finally, secure the note with a secondary lien on the company accounts receivable and intellectual property. If the buyer defaults, you must have the immediate right to accelerate the note and trigger an option to convert your unpaid balance into senior preferred equity. This structure aligns the buyer incentive to pay you back quickly while protecting your capital.