The PE Deal Series · Post D.9
View the full series →Subordinated Seller Notes — Last in Line, First to Lose
Your money is behind the bank's. And the bank doesn't care if you ever get paid.
You think "subordinated" means "lower priority." It does. But in practice, it means something closer to "last in line, first to lose, and nothing you can do about it."
Seller notes in PE deals are almost always subordinated to the buyer's senior debt. The bank that finances the acquisition gets paid before the founders who sold the business. Most founders hear "subordinated" and think of it as a sequencing issue. It's not. It's a structural barrier that can make their notes nearly uncollectible.
The Lifeboat
A ship sinks. There are two lifeboats. First class gets the first boat — that's the bank's senior debt. It's full. It's launched. Everyone in it survives.
Second class gets whatever is left. If there's a second boat, they're fine. If there isn't, they drown.
Subordination works the same way. Senior lenders get paid first from the company's cash flow. They get paid first in a restructuring. They get paid first in a liquidation. Seller note holders get whatever remains after the senior debt is satisfied. If the company is healthy, the sequence doesn't matter much. If it hits distress, the seller notes become paper.
Where Crossfield's Notes Sit
National Commercial Bank (NCB) provided the acquisition financing for Ridgeline's purchase of Crossfield. NCB's senior debt sits ahead of the $15M in seller notes. NCB gets paid first. Every quarter. No exceptions.
The subordination agreement means Ridgeline cannot make principal payments on the seller notes if doing so would violate NCB's debt covenants — or if NCB declares a default, even a technical one. Interest payments are permitted. Principal is not guaranteed.
In practice: if Ridgeline's debt-to-EBITDA ratio drifts above the covenant threshold, NCB can block all principal payments to the founders. Not because Ridgeline lacks the money. Because the covenant says they can't distribute it.
Ridgeline used NCB's financing to acquire two bolt-on companies in the 18 months after closing. Each acquisition increased the senior debt balance and tightened the covenant headroom. The founders' ability to collect principal now depends on a debt ratio they can't see, governed by a lending agreement they're not party to.
The subordination didn't just put the founders behind NCB. It gave a bank with no relationship to the founders veto power over whether they get paid.
Deal Spectrum: 9/10
The left column shows what a founder-favorable version of this term looks like. The right column shows what Crossfield signed.
The mental model is the Payment Waterfall. Every dollar the company generates flows through a priority stack. Senior debt drinks first. Seller notes drink second — if there's anything left. Subordination doesn't just affect timing. It determines whether the founder ever sees the money.
The Crossfield Moment
Nine months after closing, James asked Ridgeline's CFO about principal repayment on the seller notes. The CFO pointed to the subordination agreement.
"NCB's covenants are tight after the second bolt-on. We can't make principal distributions until the leverage ratio comes down."
"When does that happen?"
The CFO shrugged. "Depends on EBITDA. Maybe Q3. Maybe next year."
James did the math. His notes earned simple interest. They were structured through an entity. They were subordinated to a growing pile of senior debt. And now they sat behind a bank that had no obligation to let him get paid.
Last in line. And the line was getting longer.
Founder Protection Tips
Minimize or eliminate subordination — push for notes pari passu with senior debt. If the bank and the founders share priority, the buyer can't use one creditor to block the other.
Negotiate a scheduled amortization timeline starting 12–24 months post-close, with protections against indefinite deferral. If repayment is purely discretionary, it won't happen.
Negotiate intercreditor protections — standstill periods, notice rights, and limits on senior lender blocking rights. You need visibility into the covenant structure that controls your money.
Push for collateral on seller notes — a first or second lien on company assets, plus corporate guarantees from the parent entity. Unsecured subordinated notes are the weakest position in the capital stack.
Keep the repayment window short — 3 to 5 years maximum — with interest rates that climb if the buyer takes longer. The longer the note runs behind growing senior debt, the less likely you see principal.
Read before you sign.