Vendor Take-Back Financing When Buying a Business in Ontario

You have found a business you want to buy, but your bank will not cover the whole price and your own savings fall short. The seller may be willing to bridge the gap by accepting part of the price later. That arrangement is called a vendor take-back, or VTB.

A VTB can make a deal workable, but it also ties you and the seller together after closing. This article explains how these loans generally work, what to document, what to check before you rely on the seller's assets, and the interest rate limit to keep in mind.

What a vendor take-back actually is

In a vendor take-back, the seller (the vendor) agrees to receive part of the purchase price after closing instead of in full on closing day. You sign a promissory note or loan agreement promising to pay the balance, usually with interest, over an agreed period. If real estate is part of the deal, the seller's loan may be secured by a mortgage on that property.

Sellers sometimes agree because it widens the pool of buyers or helps close a sale that would otherwise fall through. Buyers like it because it lowers the cash needed on closing. The trade-off is that the seller now has a financial stake in how you run the business, and you owe a debt that has to be repaid from its earnings.

The terms your loan documents should cover

A vague handshake loan is a common source of disputes. The written terms should leave nothing important to assumption. A lawyer can tailor them to your deal, but these are the usual points to settle.

• The amount borrowed and how it fits into the total purchase price
• The interest rate, how it is calculated and when it is paid
• The payment schedule, including whether you pay interest only at first
• Whether you can repay early, and whether any penalty applies
• What counts as a default and how long you have to fix it
• What the seller can do on default, such as demand the balance or enforce security
• Whether the seller ranks behind or ahead of your bank lender
• Whether the seller can set off amounts the seller owes you against the balance, for example if a promise in the sale agreement turns out to be wrong

If a bank is also lending, it will often want the seller's claim to rank behind its own. That ranking is usually set out in a separate written agreement between the lenders, and it is better to negotiate it before closing than after.

Keep the interest rate within the law

Interest on a VTB is negotiated, but it is not unlimited. Under section 347(2) of the Criminal Code, the criminal rate of interest is an annual percentage rate, calculated under generally accepted actuarial practices, that exceeds 35 per cent on the credit advanced. Charging above it is an indictable offence carrying up to five years' imprisonment, or a summary offence carrying a fine of up to $25,000 and/or up to two years less a day in jail.

The risk is that fees, bonuses or penalties added to the loan can push the effective annual rate higher than the stated rate. Whether any exemptions apply to a particular commercial loan is something a lawyer should confirm for your structure rather than assume.

Security, liens and who gets paid first

A seller who lends part of the price will usually want security, meaning a claim over assets that can be enforced if you stop paying. Typical choices include a general claim over the business assets, a personal guarantee from you, or a mortgage if real property is involved. The type of security you offer affects your ability to borrow elsewhere later.

On your side, you will want to know what is already owed against the assets you are buying. Ontario's Access Now service lets a buyer search the Personal Property Security Registration system for liens against a seller's assets. The listed fees include $8 for an online response and $8 for a certificate response, and searches can be paid by Visa or Mastercard credit or debit card, or from a prepaid deposit account.

Other points that affect a VTB purchase

A VTB does not replace the usual checks in a business purchase. If the WSIB account of the seller is relevant, the buyer must request a WSIB purchase certificate before the date of sale. If the buyer does not obtain a valid certificate, the WSIB says it may hold the buyer liable for all amounts the vendor owes up to the sale date. The certificate is valid for 30 days from the issue date printed on it, and a new one must be requested if closing does not occur within that period.

Tax treatment also matters. When you buy a business, the price is allocated across assets. CRA says to use the individual asset prices in the sale agreement if they are set out and reasonable. If not, the price is allocated to each asset at fair market value, then to inventory, with any remainder going to goodwill (Class 14.1). The way a VTB is structured can affect the seller's tax position too, so both sides should speak with an accountant.

What to do next

Before you agree to a VTB, get the proposed terms in writing, even as a short summary. Then have a lawyer review the sale agreement, the note and any security together, because they depend on each other.

• Ask the seller for the proposed amount, rate, term and security in writing
• Run a lien search on the seller's assets through Access Now
• Ask your bank how it wants the seller's claim ranked
• Request the WSIB purchase certificate before the sale date, if it applies
• Have an accountant review how the price will be allocated
• Ask a lawyer to confirm the effective interest rate is lawful

Frequently asked questions