Guide
Vendor financing: take-backs and earn-outs
When part of the price is paid after closing, and what to watch for.
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Vendor financing means the seller gets part of the price later instead of all of it at closing. The two common forms are a vendor take-back (VTB), where the seller lends part of the price to the buyer, and an earn-out, where part of the price depends on how the business does after the sale.
Both can help a deal happen. Both also mean you, the seller, carry some risk after you’ve handed over the keys. This guide explains how they work in plain terms so you can have a good conversation with your lawyer and accountant.
General information only, not legal, tax or lending advice. Every deal is different.
Why vendor financing comes up
Most buyers of small and mid-sized businesses in BC borrow part of the price, often from a bank or BDC. Lenders look hard at cash flow, security and the buyer’s own money in the deal. When there’s a gap between what the lender will fund, what the buyer has, and what the seller wants, vendor financing can fill it.
It also sends a signal. A seller who is willing to wait for part of the money is telling the buyer, and the bank, that they believe the business will keep doing well.
Vendor take-back
How a VTB works
At closing, the buyer pays most of the price. The seller takes back a promissory note for the rest, which the buyer repays over an agreed period with interest. The terms are whatever the two sides agree, set out by their lawyers.
A VTB is usually ranked behind the bank. If the business struggles, the bank gets paid first. That is the main risk for the seller, and it’s why the details matter.
- Amount
- How much of the price is deferred. Keep it to an amount you could live without if things went badly.
- Term and payments
- How long, how often, and whether there is a period with interest only.
- Interest rate
- Agreed between buyer and seller. Your accountant can explain the tax side of interest you receive.
- Security
- A general security agreement, a personal guarantee, or both. Ask your lawyer what is realistic behind a bank.
- Ranking
- Lenders usually require the VTB to sit behind their loan, and may limit when the seller can be paid. Read the lender’s terms closely.
- Default
- What happens if payments stop, and what you can do about it.
Earn-outs
How an earn-out works
With an earn-out, part of the price is paid later, only if the business hits agreed targets: revenue, gross profit or earnings over one or more years after closing. It’s a way to bridge a gap when the seller expects growth and the buyer isn’t sure.
Earn-outs sound fair and can be hard in practice. Once the buyer owns the business, they make the decisions that affect the numbers. Clear definitions are everything.
- Pick a simple measureRevenue is easier to check than profit, which depends on how the new owner spends money.
- Keep it shortOne or two years is easier to live with than five.
- Write the accounting downHow the number is calculated, who prepares it and when you get to see it.
- Plan for disputesAgree in advance how a disagreement gets settled.
Questions to ask before you agree
- If I never received the deferred part, would I still be happy with the deal?
- How strong is the buyer, and what security am I getting?
- What will the bank’s terms let me do if payments stop?
- How will the deferred amount be taxed, and when? Ask your accountant about capital gains reserves and the capital gains deduction before you agree on structure.
- Is the extra complexity worth it? Sometimes a slightly lower price in cash is the better deal.
Cash at closing is usually worth more than the same amount later, because it’s certain. Compare offers on what you actually receive and when. See how deal structure affects price.
For buyers
Asking for some vendor financing is normal and reasonable. It keeps the seller interested in a smooth handover and can make your bank more comfortable. Ask early, explain why, and be ready to offer security. A seller is more likely to agree when they trust the person they’re lending to. See buying a business.