The buyer wants us to finance part of the transaction with a seller note, but they are refusing to grant us any operational covenants or oversight rights post-close. How do we structure this note to protect our capital without micro-managing their operations?

Question

Tyler Smith · Accepted Answer

Carrying a seller note is a common way to bridge a valuation gap, but without protective covenants, you are essentially providing an interest-free loan with zero leverage if the buyer mismanages the business. You must secure operational and financial veto rights to protect your capital.

First, establish clear financial covenants in the note agreement. These should include maintaining a minimum debt-service coverage ratio and a maximum leverage ratio. If the buyer breaches these ratios, it must trigger an immediate default, giving you the right to accelerate the note or take corrective action.

Second, secure negative covenants that prevent the buyer from taking risky actions without your written consent. These should include limits on executive compensation, prohibitions on taking on additional senior debt, and restrictions on selling off key assets of the business.

Third, ensure you have the right to receive regular financial reports, including monthly profit and loss statements and balance sheets. This keeps you informed of the company's financial health and allows you to spot trouble early. By building these protections into the seller note, you safeguard your investment while giving the buyer the operational flexibility they need to run the business.