The buyer is asking us to finance twenty-five percent of the purchase price with a seller note, but we want an equity kicker in exchange for taking on this debt risk. How do we structure warrants or conversion rights in a seller note to capture upside if they recapitalize or sell?

Question

Tyler Smith · Accepted Answer

When a buyer asks you to carry a seller note, you are acting as their junior lender. This increases your risk profile significantly, especially if the note is subordinated to senior bank debt. To justify taking on this risk, you should negotiate an equity kicker in the form of warrants or conversion rights that allow you to capture future upside.

Warrants give you the right, but not the obligation, to purchase a specific percentage of the buyer equity at a fixed price, usually a nominal amount, before a set expiration date. If the buyer grows the business and sells it or undergoes a recapitalization, your warrants can be exercised immediately prior to the transaction, allowing you to participate in the second exit.

To structure this effectively, focus on three critical terms. First, ensure you have anti-dilution protection so your warrant percentage is not watered down by future equity issuances. Second, secure tag-along rights, which force the majority owners to include your equity in any future sale of the company. Third, establish clear put option rights that allow you to force the buyer to repurchase your warrants at a fair market value after a specific period, such as five to seven years, if no exit occurs.

Alternatively, you can structure the seller financing as a convertible promissory note. This allows you to convert the outstanding principal and accrued interest into equity at a predetermined valuation if the buyer meets certain milestones or fails to pay down the note on time. This structure provides a strong incentive for the buyer to make timely payments while giving you a meaningful stake in the company if they fail to do so.