Seller Note Creativity

by a searcher from The University of Chicago - Booth School of Business

5 years ago

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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7 comments

professional from William Mitchell College of Law

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.

5 years ago | like reply | 5 likes

searcher from Harvard University

I'm actually more curious about the flip side of this --- how to add covenants to the sellers note so that the seller isn't screwing you out of a deal. Say, something like, if your business doesn't do at least 80% of ur stated EBITDA (this especially true for non-easily verifiable businesses like cash based businesses), then I'm not paying the full seller's note. Anyone ever try to add covenants like that to your seller's note?

5 years ago | like reply | 0 likes

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