The buyer is asking us to carry a seller note for fifteen percent of the purchase price, but their senior bank is demanding we accept a complete payment blockage if the company's debt service coverage ratio falls below a certain threshold. How do we structure our subordination agreement to protect our cash flow?

Question

Tyler Smith · Accepted Answer

Senior lenders will always try to push seller notes to the absolute bottom of the capital stack. A payment blockage clause means that if the buyer misses a bank covenant, your monthly interest and principal payments stop instantly, turning your exit proceeds into an unpaid loan. You cannot eliminate subordination, but you can limit its teeth.

First, negotiate a strict limit on the duration of any payment blockage. Do not agree to a permanent halt. Insist on a blockage period capped at ninety to one hundred and twenty days, after which payments to you must resume unless the senior lender has accelerated their debt or filed for bankruptcy.

Second, limit the bank to one blockage period in any twelve month cycle. This prevents them from repeatedly using minor covenant defaults to starve you of cash.

Third, ensure that while payments may be temporarily blocked, interest continues to accrue on your seller note at a higher default rate, and that unpaid amounts are capitalized into the principal.

Use the Trust Equation to manage this negotiation. By showing the buyer and their lender that you understand their need for security, but that your self orientation is protected by reasonable caps, you can build a balanced compromise. Do not let the buyer hide behind the bank's demands. Force them to inject more equity or provide a personal guarantee to bridge the gap if the bank terms are too restrictive.