Financing through a vendor loan

In this article, we will explain what a vendor loan is, why you should or should not use it, what options there are and what you should look for when applying it.

What is a vendor loan?

A vendor loan (also called the "seller loan" or the "seller credit") is an agreed deferred payment of (part of) the purchase price. Since the seller receives this part of the agreed purchase price later, it is therefore actually co-financing the acquisition, which explains the term vendor loan. This deferred payment must be formalized in a loan agreement and (in the case of a combination with a bank loan) a subordination deed that the parties will have to sign together with the bank.

What are vendor loans used for?

There are several reasons why the vendor loan is used in a transaction: if the buyer does not manage to pay or finance the entire purchase price himself, the last part of the purchase price is provided by the seller with a vendor loan to allow the transaction to go through anyway.

A commonly heard argument is that a vendor loan also motivates the seller to remain involved with the business for several more years. Often the seller plays a key role in the company to be acquired, and the buyer is keen to keep this capital on board as much as possible. The vendor loan is one way to do this.

In addition, the provision of a vendor loan gives the buyer but also the bank involved a positive signal that the seller also has confidence in a good future for the company after the acquisition. The bank therefore often requires that the seller co-finances the financing.

In practice

Suppose the seller transfers his business on the agreed date. He or she can then receive on that same date the sum of the buyer's own funds plus the foreign capital provided (the bank loan) by the bank.

The part that the vendor himself lends to the buyer is only paid in the following years according to an instalment schedule to be agreed.

In practice, we see that the vendor loan is also often requested as a requirement by the bank if they feel that the buyer is not bringing in enough equity.

Are there risks to a vendor loan?

Vendor loans are almost always subordinated to other financing (the bank loan). This means that the seller's loan (the vendor loan) may be repaid only after the bank has given permission. So there will have to be enough cash flow to provide for a repayment to the seller. If the cash flow (according to the bank) is not sufficient, the payment to the seller will be postponed. It is therefore important to make proper arrangements when entering into a vendor loan.

In addition, the vendor loan often has a long term: if the bank loan lasts 5-7 years and there is not sufficient cash flow, the seller may have to wait a long time for the subordinated part of the agreed purchase price.
And during that time anything can happen that makes the acquired company not do as well as expected. In the worst-case scenario, the seller will not see any of the loan provided, and that can be a significant risk (depending on the company).

So it is important for a seller to maintain some kind of control over his or her former company and the new owner. This can be done by agreeing to certain security deposits. For example, we sometimes see trademark rights transferred definitively only after payment of the full purchase price.

Alternatives to the vendor loan

There are several ways in which the seller can contribute to the buyer's financing. Vendor loan normally refers to the subordinated vendor loan discussed in this article, but there are other ways in which the seller can contribute:

1. Regular loan: The seller provides a regular loan to the buyer with agreed payment terms and interest payments, without further counter performance. In practice, an involved bank will require that this is also subordinated to the bank's financing and the bank will co-judge the terms of this loan. Thus, there is little difference from the usual vendor loan except that it is subordinated only to the bank.
2. Earn-out: A common way to close the gap between asking price and bid. There are many risks involved in an earn-out, and its implementation often creates hassles between buyer and seller. 
3. Partial transfer: You can also decide not to transfer all the shares until the full purchase price is paid. Suppose 30% of the purchase price is covered by the vendor loan, then the last 30% of the shares would not be transferred to the buyer until the vendor loan is also paid.

Tips when providing a vendor loan

It should be clear by now: there are as many disadvantages to a vendor loan for the seller as there are advantages for the buyer. The seller will always prefer a direct cash payment to a vendor loan and a buyer will always prefer that part of the purchase price can be paid by means of a vendor loan. However, the practice is that in the necessary deals the vendor loan cannot be avoided and without this additional loan a transaction will not go through.

Should you provide (or enter into) a vendor loan pay attention to the following points and avoid problems during the term:

1. Agree that the buyer will not pay dividends until the loan is paid off and that management fees will not be increased without permission (i.e., keep a grip on liquidity). Periodic inspection of the figures would support this.
2. Agree to continue business operations in a normal manner (as before the acquisition) while maintaining organizational structure and significant assets.
3. Include a clause requiring approval of a change of control ("change of control").
4. Get an understanding of the terms of other lenders (so that it is clear whether regular repayment of the vendor loan is feasible).
5. Agree on an interest rate on the vendor loan and ensure that it does have to be paid periodically, so that only principal repayment is subordinated.
6. Ask for collateral such as a security deposit on private or trademark rights.
7. Keep an eye on the finances, for example by receiving the complete annual report annually.
8. A vendor loan greater than 30% is exceptional and not advisable for a seller.
9. Any penalties for breaking agreements (such as the immediate collectability of the vendor loan).
10. Agree that the buyer may not take out new loans without the seller's consent.

With this article, hopefully you have gained a better understanding of the vendor loan phenomenon. If you still have questions about this method of financing, please get in touch via your Businessforsale.eu.