Vendor financing when you sell your business
You lend the buyer part of the price, which is routine in smaller Canadian deals. Here is what to ask for so the note keeps its face value, with a worked example in dollars.
Vendor financing, or a vendor take-back, is a seller’s loan to the buyer for part of the price, repaid with interest over two to five years. It is routine in Canadian business sales under about $2 million and widens the pool of buyers. The note holds its value when it is secured and the buyer’s right of set-off is limited.
What vendor financing is
You lend the buyer part of the price. They pay most of it at closing, from their own money and a bank loan, and pay you the rest over a term, with interest, under a promissory note. In Canada this is often called a vendor take-back, or VTB.
Vendor financing is routine. In deals under about $2 million most sales include some, and a buyer who asks for it is following the usual pattern. A bank lending on a small business usually wants to see the seller with something at stake, as the piece on financing a business acquisition explains from the buyer’s side. A sale to an employee ownership trust works on the same principle at a larger scale, with the trust paying the seller from company profits over many years.
Why buyers ask for it
- The bank will lend up to a level, and the price is above it.
- The bank requires it, as a sign the seller believes in the business they are selling.
- It keeps you interested in the handover, because you are paid from the business’s success.
- The buyer wants an adjustment mechanism: a note is easier to set off against a claim than cash already paid.
Why sellers agree to it
Sellers agree because it widens the pool of buyers, and a wider pool supports a higher price. A business priced at $1.5 million and sold for cash is open only to buyers who can raise $1.5 million. Put $300,000 of the price on a note and it is open to buyers who can raise $1.2 million, which is a larger group.
A note can also be worth more than the same sum in cash. A secured note that the buyer pays on time returns more than the cash would earn in the bank, provided the rate is sensible. The security is what makes that return dependable.
There is a tax effect as well. When part of the price arrives in later years, the CRA generally lets you spread the taxable gain with a capital gains reserve, which brings the whole gain into income over at most five years.
The terms that matter
| Term | What to ask for |
|---|---|
| Amount | A minority of the price. Ten to thirty percent is common, and a larger share should be priced as risk |
| Term | Two to five years, paid monthly or quarterly through the term |
| Interest | A rate above what the bank pays you and near what the bank charges them |
| Security | A charge on the business’s assets or shares, behind the bank if the bank insists, and a personal guarantee from the buyer |
| Default | What happens if a payment is missed: the whole note becomes due, and you can take the security |
| Set-off | Whether the buyer can withhold payments against claims, and if so, how a claim has to be proved first |
Set-off is the term buyers push for and sellers overlook. It means the buyer holds back note payments against a claim, and left open it lets an unhappy buyer stop paying and argue later. The note should require each claim to be made in writing with an amount attached. The two of you, or an arbitrator, then have to settle it before any payment is held back.
A worked example
Take, as an illustration, a business that sells for $1.8 million. The buyer puts in $500,000 and borrows $1 million from the bank. The seller takes the remaining $300,000 as a note over four years at 7 percent, secured on the business behind the bank, with a personal guarantee.
The seller receives $1.5 million at closing and roughly $7,200 a month for four years, about $345,000 in total. If the buyer runs the business well, the seller has earned $45,000 for waiting.
If the buyer fails in year two, the seller has a claim on a business the bank is also claiming, and a guarantee from someone who has just lost $500,000. Both outcomes are real, and the price of the note should reflect the second.
What to check about the buyer
A note is a loan, so the questions are a lender’s questions. Ask what the buyer has run before and how it went, and what they own that a guarantee could reach. Then ask to see the bank’s commitment to lend the rest, in writing, with its conditions. A buyer who refuses these questions is a buyer to sell to for cash or to pass over.
Where it sits with the other parts of the price
Vendor financing, earnouts and holdbacks are all price paid later, and a buyer may propose all three. Added together they can leave a seller with half the headline at closing. Read them as one number: what do I have on the day, and what do I have to wait for. Earnouts and reading a letter of intent cover the other two.
This piece describes vendor financing in general terms. The note is a legal document with tax consequences, including the timing of the gain, so your lawyer should draft it and your accountant should review it before you agree the terms.
Questions owners ask
- How much vendor financing is normal in a business sale?
- Ten to thirty percent of the price is common for owner operated businesses in Canada. Banks lending on a small business purchase often want to see the seller carrying some of the price. Above a third, treat the note as a risk and price it accordingly.
- What interest rate should a vendor take-back charge?
- Set the rate above what a bank would pay you on the cash and near what a bank would charge the buyer. The note is a loan to a small business with limited security, and its rate should match that risk.
- Is vendor financing risky for the seller?
- The risk depends on how the note is secured. A note secured on the business behind the bank and backed by a personal guarantee from a buyer with a record is a reasonable risk. An unsecured note from a buyer whose only asset is the business is close to a gift with an interest rate.