Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The Interest Rate Adjustment Clause That Cost a Seller 30 Million
Transcript
- Lucas: So, Luna, I was digging through a recent deal file from a lower middle market manufacturing firm that sold back in early 2025, and I found a clause that ended up costing the seller thirty million dollars. It wasn't some exotic legal trap — it was an interest rate adjustment clause that looked completely standard on the surface. Luna: Thirty million? That's not a rounding error. What was the deal size? Lucas: The enterprise value was around two hundred million. So we're talking fifteen percent of the purchase price evaporating because of one paragraph buried in the definitions section. And the frustrating part is, the seller's advisors likely saw it — they just didn't model it properly. Luna: Before we get into the weeds — and I know we're about to — if you're getting value out of these conversations, a couple of dollars a month genuinely keeps the show going. You can find us at buy me a coffee dot com slash fexingo. It's how we stay ad-free and keep digging into these real-world deal post-mortems. Lucas: Yeah, it truly makes a difference — even a small contribution helps cover the research and production costs. So, back to this deal: the seller was a Midwest manufacturer with solid EBITDA, a loyal customer base, and no real red flags in due diligence. The buyer was a pe backed platform doing a roll-up, and they needed debt financing to close. Luna: Right, and that's where the interest rate comes in. The buyer's bank was quoting them a floating rate based on SOFR, and I'm guessing the purchase agreement tied something to that rate. Lucas: Exactly. The purchase price was structured with a mix of cash at closing and a seller note. The seller note had a fixed interest rate of, say, six percent. But there was what they called a 'rate adjustment provision' that allowed the buyer to reduce the note's interest rate if their own financing costs dropped below a certain threshold. Luna: Wait, so the buyer gets to lower the rate they're paying the seller if their own borrowing gets cheaper? That sounds like a one-sided benefit. Lucas: On paper, it was meant to align incentives — if the buyer's cost of capital decreased, they might be less likely to default on the note. But in practice, it shifted interest rate risk entirely onto the seller. The seller's team assumed rates would stay flat or rise, which was a reasonable bet at the time. Instead, the Federal Reserve started cutting rates in late 2025, and by mid-2026, SOFR had dropped a hundred and fifty basis points. Luna: So the buyer's financing costs fell, and they immediately invoked the clause to reduce the interest rate on the seller note. That's brutal — the seller gets less income over the life of the note, and the present value of that note drops. Lucas: Exactly. The note's principal was a hundred and fifty million, and the rate cut from six percent to four and a half percent over a seven-year term. When you discount those lower cash flows back to present value, the seller lost roughly thirty million dollars. And here's the kicker: the clause didn't have a floor. There was no minimum rate, no cap on how low it could go. Luna: Usually in these notes, you'd at least see a floor at, like, three percent or something. A floor would have limited the damage. Why would the seller agree to no floor? Lucas: That's the million-dollar question — or thirty-million-dollar question in this case. The seller was a founder in his late sixties, eager to retire, and the buyer was offering a premium valuation. The seller's legal counsel was a general practitioner who handled estate planning and the occasional business sale, not a dedicated M&A attorney. They saw 'rate adjustment' and assumed it was a standard provision, which it is, but they didn't push back on the missing floor. Luna: So the seller's advisors underestimated the risk. That's a recurring theme in these stories. But what about the buyer? Were they being predatory, or was this just a negotiating win? Lucas: I don't think it was predatory in a malicious sense — the buyer's CFO probably just saw an opportunity to reduce their cost of capital over time. They included the clause in their initial term sheet, and when the seller didn't object, it stayed. In fact, I've seen similar clauses become more common in 2026 because buyers are worried about rate volatility and want to hedge their bets. But the buyer's team absolutely knew what they were doing. Luna: And in this case, the rate environment played into their hands. I remember that in the first half of 2026, the market was pricing in a good chance of further cuts, which made the clause even more likely to be triggered. Lucas: Right. And the seller's financial model didn't include any scenario analysis on rates. They had a base case where rates stayed flat, a bullish case where they rose, but no bearish case where they fell significantly. If they had run a simple stress test — say, a two-hundred-basis-point drop in SOFR — the impact on the note's present value would have been obvious. They could have negotiated a floor, or a cap on the adjustment, or even a make-whole provision. Luna: Make-whole provision? What does that mean for someone listening who might be selling their own business? Lucas: A make-whole provision essentially guarantees the seller receives the full economic value of the note as if the rate hadn't changed. If the buyer lowers the rate, they have to pay the seller a lump sum to compensate for the lost interest. It's a common feature in corporate bonds, but it's rare in seller notes unless the seller's advisors know to ask for it. Luna: So in this deal, the seller could have asked for a make-whole, a floor, or even a cap on how much the rate could decrease. Any of those would have protected them. But they didn't know the option existed. Lucas: Exactly. And that's the broader lesson here — it's not just about the specific clause, but about the need for sellers to bring in advisors who actually understand M&A. A general attorney might be great at reviewing a lease, but when you're selling a company for two hundred million, you need someone who's seen these provisions in action and knows the common traps. Luna: And I'm guessing the buyer's team also had a clause that tied the note's rate to their actual financing costs, not just a market benchmark. Did they have to prove their costs went down, or was it automatic? Lucas: That's another subtlety. In this agreement, the clause was tied to a broad market index, not the buyer's specific financing. So even if the buyer's own credit spread widened and their all-in cost of debt actually increased, they could still invoke the clause because the index had dropped. The seller didn't have access to the buyer's internal financing terms, so they couldn't challenge it. That lack of transparency is common and makes these clauses even more dangerous for sellers. Luna: So sellers are essentially betting on the direction of interest rates without any control. That's a very uncomfortable position. Lucas: It is. And it's why I wanted to highlight this case — because on the surface, the seller was a successful manufacturer with steady cash flows. They weren't a distressed seller making a desperate deal. They just got caught by a macro shift that they didn't structure against. Luna: Were there any other red flags in the agreement that we should mention? I know you love a good list. Lucas: Ha, well, there were two other provisions that caught my eye. First, the seller note was unsecured, which meant if the buyer went bankrupt, the seller would be at the back of the line with other unsecured creditors. Second, the note had a prepayment penalty that was actually quite favorable to the seller — but that was a small win in an otherwise lopsided deal. Luna: So the seller got one clause right, but missed the bigger picture. That's a classic case of missing the forest for the trees. In the end, what would you tell a seller who’s looking at a similar note structure? Lucas: Three practical things. One: always run a sensitivity analysis on interest rates, even if you think you know the direction — and use a range that surprises you. Two: push for a floor on the note's rate, ideally at the original rate or a couple of hundred basis points below it, to cap your downside. Three: make sure any adjustment is tied to the buyer's actual financing costs, not a market index, and require them to provide evidence if they invoke it. Luna: That's solid advice. And I'd add one more: hire an M&A advisor who has seen a few dozen deals, not just a generalist. The cost of good advice is a fraction of what it could save you. Lucas: Absolutely. Look, this deal closed, the founder got his payout — but thirty million less than he should have. And the irony is, he probably thinks the deal went fine. He doesn't even know what he lost. Luna: That's the quiet tragedy of these traps. It's not like a litigation disaster where you see the bill coming. It's just a slow bleed over years. Lucas: Right. And that's why we keep doing these post-mortems — to help the next seller spot the bleed before it starts. If you're in the middle of negotiating a deal right now, take a hard look at your seller note, your working capital peg, your earnout — and definitely your interest rate adjustment clause. It might be the one paragraph that decides whether you retire comfortably or just comfortably enough. Luna: Well said. And as we wrap up, I'm curious — have you seen any deals where a seller actually got a favorable rate adjustment clause? I'd love to hear a positive example for once. Lucas: Funny you ask. I actually came across one last month where the seller's attorney, a sharp M&A vet, insisted on a floor at the initial rate, and the buyer agreed after a bit of back and forth. That seller dodged a bullet when rates dropped. It just shows that these clauses aren't always deal-breakers — they're negotiation points, and you have to know which ones to fight for. Luna: That's encouraging. So the lesson isn't to walk away from any deal with a rate adjustment clause — it's to understand it and negotiate the terms from a position of knowledge. Lucas: Exactly. And that's the whole game in M&A: understanding what you're signing and being willing to push back. The buyer's team respects a seller who knows their stuff — it usually leads to a better deal for everyone. Luna: On that note, Lucas, I think we've given our listeners plenty to chew on. Let's leave them with that thought: negotiation isn't about being adversarial; it's about being prepared. Lucas: Perfect. Thanks for listening, and here's to your next deal being a clean one.