What is a vendor loan?

The Covid-19 pandemic and the war in Ukraine have introduced economic uncertainties. This uncertain climate often complicates negotiations between sellers and potential buyers. What does the future hold? Will the situation return to "normal" quickly? Which "reference" EBITDA should be used for valuation?

This can quickly turn into a stalemate. Fortunately, there are techniques and tools to reconcile differing viewpoints. Since 2020, earn-outs (payment of part of the acquisition price depending on future results) and vendor loans are used more frequently. Today we will explore this latter mechanism.

What is a vendor loan?

As the name implies, it is a loan provided by the seller to the buyer through a (partially) deferred payment. For example: with an acquisition price of 2 million euros, the seller agrees to a payment of €1,700,000 upon transfer of the shares and a payment of €300,000 x years after the sale. This second payment is the "vendor loan."

This payment has no specific conditions attached (unlike the earn-out). This amount is irrevocably owed to the assignor. The seller grants the buyer a payment term for part of the acquisition sum.

A vendor loan should not be confused with a staggered sale, where shares are sold in different tranches. In the case of a vendor loan, all shares of the company are immediately transferred, only part of the acquisition sum payment occurs later.

How common is a vendor loan?

Very common, especially since the health crisis. According to Vlerick’s M&A Monitor 2021, in 43% of the transfers in 2020, a vendor loan was granted. This percentage even rises to 54% in the sales segment between 1 and 5 million euros. So this practice is far from anecdotal.

Why use a vendor loan?

In most cases, it is the buyer who requests a vendor loan. This may be due to a lack of solvency. Banks typically require between 20 and 30% equity to finance the operation. If the buyer’s own funds are insufficient, a vendor loan can be used to complete the financing plan. The bank will consider the vendor loan as quasi-equity subject to "subordination." It involves money that the buyer will not have to borrow from the traditional bank circuit.

Another reason might be the potential buyer’s fear of the future. A vendor loan is a way to share risk with the seller. This way, the buyer is partially protected against an unfavorable economic situation. He can also see the vendor loan as an incentive for the seller to support him in the years following the transfer, if desired.

A vendor loan can facilitate the financing of a business transfer

Does it pose a risk to the seller?

Is a vendor loan a way to share risk with the seller while the payment is not subject to certain conditions, unlike earn-outs? Yes, that’s correct. The amount is owed to the seller regardless of future results, but the buyer must still have the means to pay it when due. If the business struggles, the buyer may likely not be able to fulfill obligations. Primarily, the buyer must pay employees, suppliers, and banks (who will have provided numerous guarantees, often also on the buyer’s private assets). Then, the fee or management fee. Only afterward will he repay the vendor loan.

Can the seller protect themselves against this risk?

Not really. The banks will have numerous guarantees, including pledging the shares of the acquired company. Banks require the seller's loan to be subordinated, meaning that in case of insolvency, banks get repaid first. There is no magic solution to protect the seller. Accepting a vendor loan means showing confidence in the company's future and the buyer's management skills. This is also one reason why banks and buyers view it positively.

Is it interesting for the transferor?

Yes, despite the risk, the vendor loan mechanism can be interesting for the seller.

Firstly, because credit means interest. The interest on a savings account is much lower than inflation nowadays. Lending money to the buyer can yield a much better return (see below).

Secondly, this significant concession to the buyer can be used to ask for something in return, like a higher total price. Not everyone is equally risk-averse. Some sellers prefer having €1,000,000 in hand on signing day. Others may prefer to receive only €800,000 immediately, with the possibility of receiving an additional €300,000 as a vendor loan (total acquisition sum €800,000 + €300,000 = €1,100,000).

What are the usual conditions for seller credit?

There are no rules, and situations vary widely.

What percentage of the acquisition price?

According to the Vlerick M&A Monitor, it averaged 16.6% of the total price in 2020. If it's mainly about ensuring the seller properly executes the transition, the percentage will be much lower. If the company operates in a sector that banks are reluctant to finance (for example, hospitality), this percentage can be (much) higher.

What is the duration?

Again, this will depend on the situation. Is the vendor loan simple protection for the buyer, or is it an essential part of their financial plan? If the support is considered a means to motivate the seller to provide necessary assistance, the duration will match that support, i.e., 6 to 12 months. If the seller's credit is essential to financing the operation, the duration will logically be longer. In most cases, the vendor loan will be repaid only after the bank loans are paid off (i.e., 5 to 7 years).

What interest rate?

The interest rate agreed between the parties will account for the risk. This increases with duration. A 0% interest rate is common if the seller's loan is very short and covers a small part of the price. Because there is no collateral, the interest rate will be higher than that granted by a bank. A 5% interest rate for a vendor loan with a 3-year duration seems "normal."

In summary

A vendor loan or the acceptance of a partial payment deferral by the seller (seller credit) can be a tool to break a deadlock in tough negotiations. However, both the seller and buyer must be aware of the limitations and specific risks of this "financing source."

Source: Un vendor loan, c’est quoi ? (Renaud Thoma - Groupe P)