The buyer is insisting that our seller note be fully subordinated to their senior bank lender, which means we cannot collect interest or principal if they breach their senior debt covenants. How do we structure subordination carve-outs or equity conversion triggers to protect our seller financing?

Question

Tyler Smith · Accepted Answer

Buyers and their senior lenders will almost always demand that your seller note be subordinated to the primary bank debt. This subordination typically prevents you from receiving payments if the buyer violates any bank financial covenants, leaving you highly vulnerable to their operational missteps. To protect your seller financing, you must negotiate critical carve-outs before signing the definitive agreements.

Start by defining what constitutes a payment blockage event. Negotiate a limit on how long the senior lender can block your interest payments. A standard market term limits this blockage to a single block of one hundred and eighty days in any twelve-month period. This prevents the bank from permanently stopping your payments over minor, non-monetary covenant defaults.

Next, include an equity conversion trigger in your promissory note. If the buyer defaults on your note or if a payment blockage lasts longer than the permitted window, you should have the right to convert the unpaid debt into senior equity or voting shares. This structure changes your status from a helpless creditor to an active shareholder.

You should also use your Business Integration Rating to demonstrate the stability of your cash flows. Use this operating history to show the senior lender that your business easily generates enough debt service coverage to pay both the bank and your seller note. By showing a track record of consistent performance, you can negotiate looser subordination terms.