The buyer wants us to carry a seller note for twenty percent of the transaction, but they are refusing to include operational covenants that prevent them from stripping our assets or over-leveraging the business. How do we structure protective covenants in the loan agreement to maintain operational oversight without overstepping our post-close boundaries?

Question

Tyler Smith · Accepted Answer

When carrying a seller note for twenty percent of the deal, you are effectively acting as a junior lender. To protect your capital without micro-managing the new owner, you must write strict operational and financial covenants directly into the promissory note and purchase agreement. Start with negative covenants. These clauses prevent the buyer from taking specific actions without your prior written consent. You must prohibit the buyer from taking on additional senior debt above a pre-approved threshold, paying out discretionary distributions to shareholders before your note is serviced, or selling off significant company assets. Next, establish positive financial covenants. Require the business to maintain a minimum debt service coverage ratio, typically defined as operating cash flow divided by total debt service payments, of at least one point two. If the business falls below this metric, it triggers a technical default, giving you the right to accelerate the note or demand additional collateral. Finally, secure information rights. You must require the buyer to deliver monthly financial packages, including an updated balance sheet, income statement, and accounts receivable aging report. Do not let the buyer hide behind corporate confidentiality. In your EOS framework, this oversight should be managed by your legacy finance lead or a designated representative who retains a seat dedicated to note compliance. This keeps the relationship professional and ensures you spot operational decline long before a payment is missed.