Canada: Vendor Take-Backs: A Useful Tool For Financing M&A Transactions

Last Updated: October 25 2018
Article by Peter Valente

Most Read Contributor in Canada, November 2018

A vendor take-back (VTB) (or "vendor financing") is a potential supplementary method of financing an acquisition transaction. It is often documented by a vendor take back note or promissory note. A VTB may be used as a type of non-consideration in conjunction with other forms of financing in order to facilitate an acquisition.

In a VTB financing arrangement, the purchaser satisfies a portion of the purchase price through financing, typically by issuing a note to the vendor. Under this arrangement, the vendor effectively loans a portion of the purchase price to the purchaser. VTBs can be used by parties to a transaction to address any shortfall between the purchase price and available cash flows. In effect, this financing tool results in the buyer purchasing the subject assets of the sale over the course of a period of time, by way of periodic payments to the vendor.

Utility of the vendor take-back

VTB financing arrangements can be excellent tools for purchasers that are unable (or unwilling) to borrow senior financing, or that do not have sufficient assets against which to borrow. These financing arrangements result in vendors continuing to bear some of the risk of the business. VTBs therefore ensure that vendors continue to have skin in the game and a vested interest in support and integration. VTBs are particularly suitable where the vendor does not require immediate access to funds, and has an interest in retaining some control over the transition of the business.

Benefits of vendor take-back financing

VTB financing is flexible tool that can benefit both parties to an acquisition by enhancing the salability of the subject asset of the sale. Some benefits include:

  • Increasing the competitiveness of the sale/auction process by expanding the scope of eligible purchasers;
  • Negotiated interest rate between the parties may translate into higher potential returns during the course of the payback period, especially in a low interest rate environment;
  • Continued involvement of the vendor during the transition period, facilitating the transfer of know-how and expertise and retaining vested interest on the part of the vendor in the purchaser's continued success;
  • An attractive alternative to financing an acquisition where other forms of debt financing are unavailable, or available at unattractive rates;
  • Avoiding ancillary fees associated with accessing the external debt market;
  • Avoiding need for the purchaser to fund 100% of purchase price at the outset; and
  • Potential tax benefits.

Challenges to vendor take-back financing

VTBs may also present challenges that should be considered and addressed by both sides to the transaction before being entered into as a method of financing, including:

  • The risk that a purchaser may default, in particular since VTB financing will be subordinated to senior debt (to extent that there is senior debt). The negotiated interest rate should adequately compensate for this inherent risk and the payback period should be appropriate;
  • Periodic interest rate payments will effectively increase the purchase price over the long term;
  • Added negotiation points may slow down or complicate the transaction, such as the amount of financing, security, payment terms (and frequency), and the interest rate, among others; and
  • More extensive conditions in favour of the vendor may be included, on account of the ongoing business relationship.

Other practical considerations

Where a purchaser is already financing part of the acquisition from another source, the vendor will, in most cases, need to postpone and subordinate its interest arising from the VTB. This is often achieved pursuant to a subordination agreement or a negotiated intercreditor agreement.

Secured vs. unsecured

VTBs can either be secured against assets of the purchaser or unsecured. In either instance, they will often be subordinated to other forms of third party debt. As a result of this subordination, the VTB will often be subject to a higher risk of default and will generally be compensated with higher interest rates. If the VTB is secured by assets of the business, execution of security documents and lien searches will be required.

Escrow agreements

An escrow agreement may also be entered into by the parties to VTB financing. Entering into an escrow agreement may mitigate some of the risks associated with this method of financing. Escrow agreements generally address the terms governing the holding and distribution of assets in escrow. When an acquisition is partially financed by a VTB, holding shares in escrow for the unpaid purchase price of the underlying business can afford the vendor a measure of protection against potential default.

Conclusion

VTB financing is a useful and important tool in the M&A toolbox. While complicated, and not suitable for every transaction, the flexibility afforded by VTB financing presents innovative alternatives to traditional lending or an attractive option to be used in conjunction with other forms of debt financing.


About Norton Rose Fulbright Canada LLP

Norton Rose Fulbright is a global law firm. We provide the world's preeminent corporations and financial institutions with a full business law service. We have 3800 lawyers and other legal staff based in more than 50 cities across Europe, the United States, Canada, Latin America, Asia, Australia, Africa, the Middle East and Central Asia.

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Wherever we are, we operate in accordance with our global business principles of quality, unity and integrity. We aim to provide the highest possible standard of legal service in each of our offices and to maintain that level of quality at every point of contact.

For more information about Norton Rose Fulbright, see nortonrosefulbright.com/legal-notices.

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