We are carrying a seller note for twenty-five percent of the purchase price, and the buyer wants the note to be fully subordinated to their new cash-flow lender. How do we structure an equity kicker or conversion feature that triggers if they refinance or sell the business early?

Question

Tyler Smith · Accepted Answer

Senior lenders almost always require seller notes to be fully subordinated, meaning you cannot get paid principal, and sometimes even interest, if the company breaches its bank covenants. This leaves you carrying significant risk with very little control. To balance this risk, you should negotiate a warrant or equity conversion feature in your seller note. If the buyer defaults on their payments to you, or if they sell or refinance the business before your note is fully paid, the unpaid balance should automatically convert into senior preferred equity or trigger a cash kicker. You can also structure the note so that unpaid interest compiles and capitalizes at a higher default rate, which disincentivizes the buyer from prioritizing other expenses over your note. To protect your position while you wait for payment, secure board-observer rights or direct access to the company's financial reports. You should require the buyer to send you their monthly financial packets, including their cash flow statements and covenant compliance certificates. By monitoring these metrics, you can spot operational trouble early. If you see their performance slipping, you can use your operational expertise to advise them before it triggers a bank default, protecting both their business and your unpaid seller note.