Seller Note Creativity

searcher profile

February 11, 2019

by a searcher from The University of Chicago - Booth School of Business in Chicago, IL, United States

We all know seller debt is a contentious issue with sellers. There is a lot of consternation around seller debt being behind the bank debt. I'm interested to hear any novel debt terms you've used to get the sellers more comfortable with their junior position on the debt schedule.

One thing I've done is to add a clause in the seller note that states that equity holders will not be paid out until the seller note has been paid off. That generally gets a good response but I'm sure there are other ideas out there.



 

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commentor profile
Reply by a professional
from William Mitchell College of Law in Minneapolis, MN, USA
Hi Ryan. A good question. Most sellers who have never sold their business will ask for a number of protections, most of which are uncommon or impractical. Be careful about offering too much upfront, even if you think they are reasonable as your seller will likely see that as a starting point and ask for far more. Restricting ANY equity payout until all debt is payed off seems harsh. A covenant that equity distributions cannot be made unless payments are current is ok (and likely part of the bank covenants), but agreeing that NO equity payments be made until all of the note is paid off is too much. As long as the seller is getting paid, that should be enough. More sophisticated deals could restrict the amount of equity distributions or require debt coverage reserves, but that’s uncommon in small acquisitions.

While I understand the desire to have a non-voting board seat, the sad fact is most sellers have a very hard time separating themselves from the business and control. At some point you need them to walk away so make a clean break. They can have the rights of a lender to periodic information. If you give them a board seat, they will keep trying to run the business and likely interfere (even unintentionally) with how you are trying to run the business.
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Reply by a searcher
from Harvard University in Midland, TX, USA
The seller note behind equity seems more like a concession than something I would do out of the gate. Too restrictive. Remember, you’re likely trying to use this mezz(ish) piece to bring flexibility to the deal, not tie your hands afterward.

Reccomendations:
- Negotiate for seller note to be on standby for a few years. PIK, no payments.
- Fixed rate if you believe rates will continue to climb. Start at a lower rate than a bank.
- Make sure they know they’re a secondary lien to the bank.
- No PGs. The fall back position here is a Security Agreement, but don’t start even with that. If you end up there, bank will likely require Seller to sign that they cannot default the business without the bank’s consent.
- No covenants. You don’t need more work with compliance every quarter.
- Be careful around how much access you grant them to come inspect the assets of the business. If the relationship turns toxic during transition, you don’t want to be bound legally to their visits wrecking your culture.
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