What it means
In most deals the buyer pays the price from a mix of its own cash and bank borrowing. If that mix falls short, the seller can agree to a vendor take-back, often shortened to VTB, which is documented as a promissory note (a written promise to pay a set amount on set dates) with an interest rate and repayment schedule.
Sellers agree for several reasons. It can win a deal that would otherwise fail, it earns interest on money they would otherwise take as a lump sum, and it signals confidence in the future of the business they are leaving.
For the buyer, it reduces the cash needed on day one. The loan is usually subordinated, which means that if the business later fails, bank lenders are repaid before the seller.
Banks like this structure because the seller's note acts as a cushion beneath their own loan, and some lenders insist on it. Terms are negotiated and commonly include interest-only payments for a period, a balloon payment (a large final repayment) at the end, and sometimes a right for the buyer to hold back payments if certain claims arise.
Sellers may also ask for security over the assets of the business. The main risk sits with the seller, who remains exposed to the business after taking the money off the table.
If the new owner runs it badly, the note may be repaid late or not at all, so a seller should assess the buyer as carefully as a bank would. From the buyer's side, the note is cheaper and more flexible than most alternatives, because the seller usually accepts a lower interest rate than a bank would charge.
The catch is that the seller can be a demanding creditor, so the buyer should read the default terms closely before signing. A sensible buyer also tests the repayment schedule against a weak year, not only a strong one.
In practice
Real-world examples.
Example
A founder sells her specialist engineering firm to a management team. The team can raise only 70% of the price, so she accepts a note for the balance, repaid over four years, and keeps a seat on the board while it is outstanding. Both sides keep a close working relationship while the note is outstanding.
Example
A family selling a restaurant group agrees to take back $600,000 of the price. The bank is willing to lend against the properties but not against goodwill (the extra value of a trading business above its assets), so the family's note fills the gap. The buyer lists the note as a debt in its cash forecast so that every repayment is planned for.
Example
An owner of a small dental practice sells to a younger dentist with limited savings. The seller takes back 20% of the price, payable over five years, which also gives the buyer an incentive to keep the patient base intact. The bank accepts the arrangement because the note ranks behind its own loan.
Formula
Calculation
Vendor take-back amount = purchase price - buyer cash contribution - bank debt
A buyer is acquiring a company for $5,000,000. The buyer contributes $1,500,000 of its own cash, and a bank agrees to lend $2,500,000. The vendor take-back = 5,000,000 - 1,500,000 - 2,500,000 = $1,000,000. If the note carries interest of 6% a year, annual interest is 1,000,000 x 0.06 = $60,000, or $5,000 a month. The seller receives $4,000,000 in cash at closing and the remaining $1,000,000 over time.Case study
Seen in the real world.
Cobalt Print Works is an illustrative, fictional commercial printer whose owner wanted to retire. The only interested buyer was the plant manager, who had $400,000 in savings, while the agreed price was $3,000,000.
A bank offered $1,800,000 against the equipment. That left a gap of $800,000, so the owner agreed to a vendor take-back at a modest interest rate, repayable over five years, ranking behind the bank.
The illustrative outcome was that the sale closed, the owner received most of his money immediately, and the note was repaid in full from the business's own profits. The owner later said the key was that he already knew the buyer's competence, which made lending to him feel less risky than lending to a stranger.
Watch out
Common mistakes.
- Treating the note as part of the cash received at closing, when it is a receivable that depends on the future performance of the business.
- Agreeing to a vendor take-back without security or a clear ranking against the bank loan, which leaves the seller exposed if things go wrong.
- Forgetting to model the repayments, so the buyer's cash flow looks fine until the balloon payment arrives.
Questions
People also ask.
Is a vendor take-back the same as an earn-out?
No, a vendor take-back is a loan for a fixed amount, whereas an earn-out is a payment that depends on the business hitting future targets.
Why would a bank prefer a deal with a vendor take-back?
The seller's note shows confidence in the business and sits beneath the bank loan, so it adds a layer of protection for the lender.
How is the seller's interest taxed?
That depends on the country and the structure of the sale, so both sides should take tax advice before agreeing the terms.
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