Senior lenders let a seller note be paid, but only as junior debt. The seller signs a subordination agreement that stops payments while the senior loan is in default, often allows payments only if the company passes its covenants afterwards, bars the seller from suing or accelerating for a standstill period, requires the note to mature after the senior loan, and puts any lien the seller holds behind the lenders'. These terms are standard, not a sign of a difficult lender. The risk is timing: if the seller has not agreed to them in the letter of intent, they surface at closing.
- Who signs
- The seller, the senior lender and the borrower
- Payments allowed
- Scheduled payments, unless a block applies or a payment test fails
- Payment blockage
- On a senior payment default, and often on a covenant default
- Standstill
- The seller cannot enforce the note for a set period after a default
- Maturity and security
- After the senior loan; unsecured, or a lien behind the lenders'
- When to agree it
- In the letter of intent, then the purchase agreement
Why senior lenders care about the seller's note
A seller note is part of the price the seller agrees to receive later, as a loan to the buyer. To the buyer it is a way to pay less at closing. To the senior lender it is a second creditor with a claim on the same cash flow and, sometimes, the same assets. The lender has sized its loan on the company's EBITDA, and it will not let a second creditor be paid ahead of it, or alongside it, when that cash is needed for the senior loan.
Banks, private credit funds and unitranche lenders generally accept a paying seller note. What they require in return is a set of subordination terms that decide exactly when the seller may be paid and what the seller may do if the note is not paid. Those terms live in a subordination agreement signed by the seller, the lender and the borrower, and the note itself is written to refer to it. The terms are close to a market standard; the danger is a seller who first sees them at closing.
The terms, one by one
A subordination agreement for a seller note usually contains six kinds of term. The table sets out what each does and where sellers usually push back.
| Term | What it does | Where sellers usually push |
|---|---|---|
| Payment subordination | The senior debt is paid in full before the seller in a liquidation or bankruptcy; the seller turns over anything received in breach | Rarely contested; this is what junior means |
| Payment blockage on a payment default | If the borrower misses a senior payment, no seller payment may be made until it is cured | Accepted by most sellers once explained |
| Payment blockage on a covenant default | If a senior covenant is breached, seller payments stop for a blockage period, which can recur | Sellers ask to limit how long a block lasts and how often it can be imposed |
| Payment conditions | Each seller payment is allowed only if there is no default and the company passes its covenants after the payment | Sellers ask for the test to be the covenant level, not a stricter one |
| Standstill on enforcement | The seller may not accelerate, sue or enforce security for a set period after a default, or while the lenders are acting | Sellers ask for a shorter period and a right to act if the lenders do nothing |
| Limits on amendments and security | The note cannot be made shorter, pricier or better secured without the lenders' consent; any lien is junior | Sellers ask for a junior lien where the lenders will allow one |
Payment blockage is the heart of it. A block on a payment default is automatic. A block on a covenant default is triggered by the lender's notice and lasts for a fixed period unless the default is cured or waived first. Well-drafted agreements limit how many covenant blocks can be imposed in a year, and that limit is the term most worth a seller's negotiating effort.
Payment conditions go further than blockage. Instead of waiting for a default, the credit agreement tests each seller payment before it is made: no default is continuing, and the company still passes its leverage and fixed charge coverage covenants after paying.
Standstill protects the lenders' control of a workout. Without one, a seller could accelerate the note and trigger a cross-default into the senior loan at the worst moment. The standstill gives the senior lenders time to decide alone.
A blocked payment is deferred, not forgiven: it keeps accruing and is paid when the block ends, unless the note says otherwise.
A payment test in plain numbers
Take a company with cash flow available for debt service of 1,500 a year. Senior debt payments are 1,000 and the seller note calls for 200. The credit agreement requires fixed charge coverage of at least 1.25x, counting seller-note payments as fixed charges.
| Year | Cash flow | Senior payments | Seller payment due | Coverage with the seller payment | Seller paid? |
|---|---|---|---|---|---|
| Year one | 1,500 | 1,000 | 200 | Exactly 1.25x | Yes |
| Year two, softer year | 1,400 | 1,000 | 200 | Below 1.25x | No: blocked and deferred |
| Year three, recovery | 1,650 | 1,000 | 200 plus the deferred 200 | Above 1.25x on the current payment | Current payment yes; the catch-up no, because coverage with it falls below 1.25x |
Two points come out of the example. A seller note that looks small against the price can be large against a covenant cushion: here, 200 of payments consumed the whole cushion in year one. And the catch-up in year three is where disputes start. Paying the current 200 leaves coverage of 1,650 against 1,200, above 1.25x; adding the deferred 200 brings it to 1,650 against 1,400, below 1.25x, so the catch-up waits another year. The agreement should say when deferred amounts are paid and whether interest runs on them while they wait. How coverage covenants are built is covered in debt service coverage ratio and covenant headroom.
Maturity, acceleration and security
Beyond payments, senior lenders look at three features of the note itself.
- Maturity. Lenders commonly want the seller note to mature after the senior loan, or at least to have no large final payment due while the senior loan is outstanding. A note that comes due first may need to be refinanced.
- Acceleration. The seller's right to call the whole note due on default is limited by the standstill, and the note's own events of default are usually narrowed: a missed seller payment caused by a lawful block is not a default under the note.
- Security. Some lenders want the seller unsecured. Others allow a junior lien on the company's assets, subject to an agreement that bars the seller from enforcing it while the senior loan is outstanding and requires the lien to be released when the senior lenders sell collateral.
Three ways a seller note can sit behind the senior loan
Subordination terms are not one-size. How much the note pays in cash while the senior loan is outstanding is itself negotiable, and it changes how lenders count the note.
| Paying subordinated note | Accruing or PIK note | Note on full standby | |
|---|---|---|---|
| Cash payments while the senior loan is outstanding | Scheduled interest and sometimes principal, unless blocked | None or little; interest is added to the balance | None |
| Counted in coverage | Yes, its cash payments are tested | Only the cash part, if any | No |
| Counted in leverage | Yes, in total leverage | Yes, and the balance grows | Usually yes, in total leverage |
| Effect on senior loan size | Can reduce it, by using up coverage | Little effect on coverage | Little effect on coverage |
| What the seller gets | Paid most of the time | Paid at maturity or on a sale, with compounding | Paid only after the senior loan |
A seller whose note is large relative to the company's cash flow may be asked to accrue part of the interest as PIK interest. How much seller financing covers how large notes usually are.
Settle it in the letter of intent, not at closing
Seller-note terms rarely break a deal because the seller refuses them. They break it because the letter of intent said nothing about subordination, the purchase agreement copied the silence, and the lender's form arrived in the final week. By then any condition on the seller's schedule looks like a price cut. The fix is to write the principle into the letter of intent and the detail into the purchase agreement, before a lender's form exists.
| Document | What to settle about the seller note |
|---|---|
| Letter of intent | That the note will be subordinated to senior acquisition financing on customary terms, including payment blockage and standstill; whether it is secured; whether interest is paid in cash or accrues |
| Lender term sheet | The lender's specific conditions: which defaults block payment, whether payments are tested against covenants, the standstill period, maturity relative to the senior loan |
| Purchase agreement and note | The note's rate, amortization and maturity, consistent with the term sheet; the buyer's right to offset indemnity claims; the seller's agreement to sign the lender's subordination agreement |
| Subordination agreement | The final terms, negotiated among seller, lender and borrower before closing |
A buyer with an early read from lenders before signing the letter of intent can put the likely terms in front of the seller at the start; see talking to lenders before the LOI. The letter of intent is also where the buyer protects itself with a financing contingency written around the structure.
What a seller can reasonably ask for
A seller who accepts subordination is not powerless. Terms that lenders commonly accept, when asked early:
- Scheduled interest payments whenever no block is in place, even if principal is held until later.
- A cap on how many covenant blocks can be imposed and for how long in total.
- A higher interest rate on amounts deferred by a block, compensating the seller for waiting.
- A guarantee from the buyer's holding company or owners, which lenders often allow because it does not touch the borrower's cash, usually on condition that the seller cannot enforce it while a block or standstill is running.
- Copies of the compliance certificates the borrower sends the senior lenders.
What sellers rarely get is a right to be paid regardless of covenants, a lien that ranks equally with the senior lenders, or a maturity inside the senior loan's term. Those turn the seller's note into senior debt, and the senior lenders would size their own loan down to match. Seller note terms in conventional deals sets out how rates and amortization are usually negotiated, and mezzanine vs a seller note compares seller paper with the institutional junior debt it often replaces.
Midas Partners's financing model shows the seller note's payments year by year beside the senior debt service and the covenant tests, so the seller and the lenders can both see in advance when a block would bite. It is part of the lender package, built in a day once the documents are in and checked by a senior banker before the client approves it.
Common questions
- Can a senior lender stop payments on a seller note?
- Yes, on the terms the seller signs. A payment default on the senior loan blocks seller payments automatically, and most agreements let the lender block them for a period after a covenant default too. Blocked amounts are usually deferred, not forgiven.
- Does the seller have to sign anything with the buyer's lender?
- Yes. Senior lenders require the seller to sign a subordination agreement with the lender and the borrower. The purchase agreement should say the seller will sign it on the lender's customary terms.
- Can a seller note be secured behind a senior loan?
- Sometimes. Some lenders require the seller to be unsecured; others allow a junior lien the seller cannot enforce while the senior loan is outstanding and must release when the lenders sell collateral.
- What happens if the seller refuses subordination terms at closing?
- The lenders will not close with an unsubordinated note, so the choices are to renegotiate the note, replace it with more equity or other junior capital, or not close. That is why the terms belong in the letter of intent.
- Does a seller note count as equity to the senior lender?
- Not usually. It is junior debt: it counts in total leverage, and its cash payments count in coverage. It lowers the cash the buyer brings, but lenders still look for real equity beneath all the debt.