We are carrying a significant seller note to help close the deal, but the buyer's senior lender refuses to let us take a security interest in the company assets. How do we structure alternative collateral or default triggers to protect our note?

Question

Tyler Smith · Accepted Answer

It is standard practice for senior bank lenders to demand absolute priority, which means they will block you from taking a second lien on the business assets to secure your seller note. If you cannot get a junior lien, you are essentially holding unsecured debt, which places you at extreme risk if the buyer mismanages the business. To protect yourself without violating the bank's subordination agreements, you must look for alternative forms of collateral and structural triggers. First, demand a personal guarantee from the buyer's principal owners, backed by specific personal assets or a pledge of their equity in the holding company. This equity pledge is crucial because it allows you to step in and seize the equity of the operating entity if they default, effectively taking back ownership of the business without needing to foreclose on the physical assets. Second, write tight operational and financial covenants into your seller note that mirror the senior lender's covenants but have slightly tighter thresholds. For example, if the buyer's debt service coverage ratio drops below a certain level, it should trigger an immediate technical default on your note. This default can trigger a steep interest rate bump, or force the buyer to seat you on their board of directors. By using these non-asset triggers, you maintain structural leverage. You ensure that if the business begins to struggle, you can step back in and run your EOS processes to stabilize operations before the senior lender can liquidate the company.