The buyer is asking us to carry a seller note that is subordinate to their primary acquisition lender, but they are also demanding that we pre-approve subordination to any future refinancing or recapitalization. How do we structure limits on this future subordination to ensure we do not get pushed down the capital stack?

Question

Tyler Smith · Accepted Answer

Carrying a subordinated seller note is a standard part of many transactions, but agreeing to pre-approve subordination to any future refinancing is a massive risk. If the buyer performs poorly or takes on excessive debt during a future recapitalization, your note could easily be pushed so far down the capital stack that it becomes uncollectible.

To protect your position, you must place strict, legally binding limits on any future subordination in your note agreement.

First, establish a cap on the total amount of senior debt that can ever take priority over your note. Specify that your subordination only applies to senior bank debt up to a set multiple of EBITDA, such as 2.5 times. If the buyer attempts to refinance and increase their leverage beyond this cap, your note must automatically move up in priority or become immediately due and payable.

Second, require that any future senior lender must agree to the same intercreditor terms as the original lender. This prevents a new lender from imposing harsher standby provisions or blocking your interest payments under subjective default definitions.

Third, include a covenant that prevents the buyer from paying dividends or making distributions to their equity holders if doing so would impair their ability to service your note. Your weekly EOS Scorecard metrics can serve as early-warning triggers here. By defining hard financial boundaries, you ensure that future refinancing cannot be used to strip cash out of the business at your expense.