How to use vendor financing to buy a business

Many small business buyers need to assemble financing from a variety of sources to complete the acquisition. Vendor financing, which is also called vendor take-back or VTB, is where the seller of the business agrees to take part of the sale price through a series of payments with interest. The seller is essentially extending debt to the buyer, where the debt is often secured against the assets of the business.

When the deal closes, the seller will receive the purchase price minus the borrowed amount. Usually, this debt to the seller ranks below other debt that you might owe to a bank or other lending institution — a risk that the seller must understand and accept.

If you want to use vendor financing to buy a business, you should let your business broker, the seller, and any other parties involved in the deal know as early in the process as possible. This way, the seller is not surprised later on, and you can work towards agreeing on several key points, including:

• The amount of the loan
• The interest rate 
• The payback period

There are a few key details you will want to agree on with the seller over the term of the loan, such as:

• Will the seller continue to have a role in the business?
• How long will they remain involved?
• What financial reporting will the buyer provide?

All of these terms and conditions can be included in the final agreement that you will both sign.

What is a vendor take back mortgage (VTB)?

A vendor take-back loan is often used to finance a business purchase, and a vendor take-back mortgage is structured much the same way, but for real estate. Both are created when the seller agrees to be paid partly in cash and partly in the form of debt from the buyer. The buyer and seller are free to work out a payment plan and interest rate that works for both parties. Indeed, the line between a VTB loan and mortgage may be blurred when a buyer purchases a business that owns its own premises. The VTB concept is a great way to make deals that might otherwise be difficult to close using third-party financing from a bank or other lender.

What are the benefits of using a VTB?

The most immediate benefit of a vendor take-back or VTB is it can help close the financing gap between the selling price of the business and the buyer’s ability to access equity and conventional debt financing. But there are many less obvious and just as important benefits, such as:

• Confidence. If the seller is willing to extend vendor take-back debt to you, it shows that they believe in the business, as often it is the revenue or cash flow of the business that will service the debt. It means they have the confidence to risk their capital over a period of years, even with someone new running the business.
• Flexibility. The first year or two of owning a business are traditionally the riskiest. It is also a time when you might incur some upfront expenses as you put your mark on the business. VTB financing often includes deferred payments or interest-only payments in the first year, which can leave you with a little more cash flow in these crucial early days. 
• Recourse. No matter how careful your due diligence was, it’s always possible that you missed something. If you end up with an overdue bill, an unpaid liability or an issue that was not disclosed by the seller, you might be able to adjust the VTB repayment to cover it.
• Vendor support. This is a great hidden benefit of a VTB. The seller now has a vested interest in your success, which means they will be more motivated to train you, help you, introduce you to key people, and generally do what they can to make sure you are successful.

Favorable terms of finance

When a buyer and seller strike a VTB deal, it is really a partnership. Both parties want the new business owner to be successful. That means the terms of the deal can be more flexible and often more favourable than borrowing from the local bank or credit union. 

Opens up opportunities to finance unsecured assets

If you want to buy a business that owns a factory full of equipment, a bank might be happy to take that equipment as security for a loan. But if you want to buy a business that has assets like brand recognition or intellectual property, you might have a hard time finding a lender who will accept those assets as security. But the seller of the business understands the value of those intangible items, and is effectively accepting them as security when they provide you with vendor financing.

Keeps business owner engaged

When a seller of a business provides a VTB, they are still invested in the business. Often, the value they can provide to the buyer goes beyond the simple operation of the business. They can share valuable knowledge and experience that can’t be captured in a training manual and help you maintain essential relationships with staff, partners, suppliers, industry peers, and other contacts. 

Gives added security and recourse for the buyer

Imagine taking over a new business only to receive a past due-bill or notice of litigation relating to events from before your time. Whether by accident or by design, the seller of the business could have failed to disclose something with present-day financial implications. If that were to happen and there is a VTB in place, you have some added recourse in the matter. For example, you could negotiate a lower repayment amount to offset the unanticipated expense. 

What does this mean for my business acquisition potential?

True, some business sellers may prefer an all-cash deal so they can make a clean break from the business. Vendor take-back financing might be a deal-killer for them. But many other sellers are going to like the dynamics of a VTB. For one, it’s going to broaden the potential market of buyers, which could help them realize a higher selling price. It’s going to give them continued cash flow after the sale date — plus interest. And, for many, the business is a place of emotional investment and point of pride, so the ability to help make sure it continues to thrive will be seen as a positive.