Better seller note design.

A common move on independent sponsor deals is a seller note at 6 percent, cash pay, subordinate to senior. A better move is a seller note at 7 percent, with a PIK toggle, deeply subordinated, with a standstill that mirrors the mezz.

The half-point of additional coupon is a rounding error. The PIK toggle is real optionality. The deep subordination is what the senior actually needs to extend the right credit.

The 6 percent cash-pay note is what sellers ask for when they have not been advised. It feels safe. The seller gets paid current. The interest expense reduces taxable income for the buyer. Everyone signs.

Then year two arrives. The platform has a slow quarter. The senior tightens covenants. The first add-on diligence is open. The buyer needs every dollar of operating cash flow for the integration. The seller note's cash payments become the marginal dollar that the platform cannot afford.

The platform pays the seller note anyway, because the documents say so. Twelve weeks later the platform misses its senior covenant.

Now contrast with the 7 percent note with a PIK toggle.

The PIK toggle is the operational difference. PIK means "paid in kind." Instead of paying cash interest, the loan accrues additional principal. The platform issues paper instead of cash. The seller's nominal return is the same (often higher with the bumped coupon and the compounding effect), but the cash burden on the operating company is zero in any quarter the PIK toggle is exercised.

The PIK toggle should be at the borrower's option, not the seller's option. Triggerable on any quarter where the platform's senior covenant headroom drops below 15 percent, or on any quarter where the platform is executing a pre-approved add-on. Outside those triggers, the note pays cash.

The deep subordination is the second piece. A seller note subordinated to mezz, with a standstill that mirrors the mezz standstill (90 to 120 days on payment defaults, longer on bankruptcy events), is treated by the senior lender as equity-like. The senior allows higher leverage. The senior covenant package is looser.

The standstill mirroring is the third piece. If the seller note has a 30-day standstill while the mezz has a 120-day standstill, the seller note can call default and force a payment block on the mezz in the worst possible moment.

A seller note is debt. Document it like debt. Treat it like debt. And price the optionality, not just the coupon.