A private equity buyer is asking us to accept a seller note that is fully subordinated to their senior bank debt, and the bank is demanding we stand still on payments if the business misses a covenant. How do we structure the subordination agreement to protect our cash flow without blocking the senior financing?

Question

Tyler Smith · Accepted Answer

When a buyer structures a deal as a seller note, they always carry risk, but subordination to a senior lender can completely freeze your payments if the buyer struggles. Senior lenders routinely demand a standstill agreement. This clause prevents you from collecting principal or interest on your seller note if the buyer violates their senior bank covenants, even if the business is otherwise generating cash.

To protect your interests, you must negotiate specific carve-outs in the subordination agreement:
- Demand a payment blockage cap of 150 to 180 days in any twelve-month period.
- Ensure that any blocked interest continues to accrue and compound, rather than being forfeited.
- Negotiate a right to receive regular operational reporting from the buyer.

Once the blockage cap is reached, the buyer must resume payments to you unless the senior lender has declared a formal default and accelerated their own debt.

Use your weekly Level 10 Meeting to keep your leadership team focused on maintaining high operational margins before the close. This maximizes the buyer's day-one cash flow, reducing the risk of a covenant breach. A strong operating system is your best defense against post-close subordination issues.