The buyer is insisting on a seller note to close our valuation gap, but they want the interest rate pegged below market levels with no personal guarantees. How do we structure the covenants and interest payments to make this a viable option?

Question

Tyler Smith · Accepted Answer

A seller note is a powerful tool to bridge a valuation gap, but without the right protections, you are acting as an unsecured lender to a business you no longer control. If the buyer refuses personal guarantees and demands a below-market interest rate, you must build security into the corporate covenants of the purchase agreement. First, negotiate a payment-in-kind, or PIK, interest structure. If the cash interest rate is low, say four percent, require that any unpaid interest compounding monthly is added to the principal balance at a much higher rate, such as ten percent. This incentivizes the buyer to pay you in cash rather than letting the debt grow. Second, secure strong financial covenants. You must insert clauses that restrict the buyer from taking on excess senior debt, paying out distributions to their equity holders, or raising executive salaries if your seller note is not being paid. You should also secure a second-lien position on the assets of the company, right behind their primary bank lender. If they default on their covenants, you must have the right to accelerate the note or, in a worst-case scenario, convert the unpaid debt back into equity. This protects your principal and ensures the buyer treats your note as a priority obligation.