Vendor take-back financing in a BC business sale: how seller financing works

When a buyer cannot borrow the full price of a business, the seller is often asked to carry part of it. In a vendor take-back, or VTB, the seller receives some of the price at closing and the balance over time, with interest.

A VTB can make a sale possible, but it turns the seller into a lender to a business they no longer control. This article explains the documents involved, how the seller's security works under BC's Personal Property Security Act, why the bank usually ranks first, and what each side should negotiate.

How a vendor take-back is documented

The purchase agreement records that part of the price will be paid after closing. The debt itself is usually set out in a promissory note or loan agreement covering the principal, interest rate, payment schedule, prepayment rights and events of default. Around that sit the security documents that give the seller something to enforce if payments stop.

The VTB terms should be settled in the letter of intent or early in negotiations, because they affect the price discussion and the buyer's bank financing. Our article on selling your business in BC sets out where this fits in the overall process.

The seller's security

An unsecured promise to pay leaves the seller standing in line with every other creditor. Sellers therefore usually ask for one or more of the following:

• A general security agreement (GSA) over the buyer's business assets. Under the Personal Property Security Act, a security interest is enforceable against third parties if the debtor signs a security agreement describing the collateral, which can be a statement covering all of the debtor's present and after-acquired personal property (s 10(1)(d)).
• A share pledge in a share purchase, so the seller can take back the shares of the company sold.
• Personal guarantees from the individuals behind a corporate buyer.
• A mortgage if the sale includes land, registered in the land title system.

Register it, or risk losing it

Taking security is only half the job. A security interest is perfected when it has attached and the steps required for perfection are completed (s 19); for most business assets that step is registering a financing statement in the Personal Property Registry (s 25). An unperfected interest is not effective against a trustee in bankruptcy if it is still unperfected at the date of bankruptcy (s 20(b)), which is exactly when the seller needs it. A financing statement can be registered before the security agreement is signed (s 43(4)), and the registration lasts for the period stated on it unless renewed before it expires (s 44).

Ranking behind the bank

Between perfected security interests in the same collateral, the general rule is that priority follows the order of registration (s 35(1)(a)). The buyer's bank will insist on ranking first, so it will usually require the seller to sign a subordination or postponement agreement. The Act allows a secured party to subordinate its interest to another, and the subordination is effective according to its terms (s 40(1)).

Those terms are where the seller's real protection is negotiated. Points to consider:

• Whether the buyer may keep paying the VTB while the bank loan is in good standing, and what stops those payments.
• A standstill period during which the seller cannot enforce without the bank's consent, and how long it lasts.
• Notice to the seller if the buyer defaults on the bank loan, and any right to cure the default or buy out the bank's position.
• Limits on increasing the bank's loan ahead of the seller without consent.

Default terms: what happens if the buyer stops paying

The note and security agreement should list events of default. Common examples are a missed payment, insolvency, sale of the business or its main assets, loss of the lease, a default under the bank loan, and a change of control of the buyer.

The Act sets some ground rules. A clause allowing the seller to accelerate the debt because it feels insecure can be used only if the seller, in good faith, believes and has commercially reasonable grounds to believe that the prospect of payment is, or is about to be, impaired, or that the collateral is, or is about to be, in jeopardy (s 16). On default, a secured party may seize the collateral or otherwise enforce as the law permits (s 58), and must give at least 20 days' notice before disposing of seized collateral to the debtor and other parties listed in the Act (s 59(6)). Until the collateral is disposed of or contracted for, a person entitled to that notice can generally redeem it by paying what is owed and the reasonable costs (s 62).

In practice, a seller enforcing against a business that is failing may recover little, especially behind a bank. Good security and well-drafted subordination terms improve the odds; they do not remove the risk.

The buyer's side

A VTB is also a negotiation for the buyer. Buyers commonly look for:

• A right of set-off, so that valid warranty or indemnity claims can be deducted from VTB payments. Sellers often resist this or limit it. Our article on key terms of a business purchase agreement covers warranties and indemnities.
• Prepayment without penalty, so the VTB can be refinanced later.
• Limits on personal guarantees, in amount or time.
• A clear discharge of the seller's registrations when the debt is paid.

Tax timing

Receiving the price over several years can affect when the seller's gain is taxed. Section 40(1)(a)(iii) of the federal Income Tax Act allows a capital gains reserve for proceeds payable after the end of the year, generally spreading the gain over no more than five years, subject to the Act's conditions. Whether a reserve is available, and how it interacts with other planning such as the lifetime capital gains exemption, is a question for your accountant before the terms are fixed.

Asked to finance part of the price? Get the note and security right first

Our business purchase and sale lawyers can draft or review the promissory note, security agreement and personal guarantees, register the seller's security, and negotiate the subordination terms with the buyer's lender, acting for either the seller or the buyer.

Call 604-259-2844 or send us a message to arrange a consultation at our Vancouver office.