A potential buyer wants us to hold a forty percent seller note to close a valuation gap, but we are worried they will run the business into the ground and default. How do we structure the covenants and security interests to protect our unpaid equity value?

Question

Tyler Smith · Accepted Answer

When a buyer asks you to finance nearly half of the transaction, you are no longer just a seller. You are their primary lender and risk partner. To protect your equity value, you must structure the seller note with operational and financial guardrails that trigger early intervention before the business deteriorates. Start by securing the note with a first-priority lien on the assets of the business, subordinated only to a capped amount of senior bank debt. Next, insert strict financial covenants into the note agreement. These must include a minimum debt service coverage ratio and a maximum leverage ratio. If the buyer breaches these covenants, it must trigger an immediate default, accelerating the balance due. Most importantly, build in operational covenants. Require the buyer to maintain the existing operating system, including the weekly Level 10 Meeting and quarterly Scorecard tracking. Your note agreement should grant you observer rights on their board or leadership team, allowing you to monitor their operational metrics. If key performance indicators drop below agreed thresholds for two consecutive quarters, you must have the contractual right to install an interim manager or regain voting control of the board. By linking your seller note directly to structured operational guardrails, you ensure that you do not write a blank check to an incompetent operator.