Vendor Loan

What is a vendor loan?

Vendor loan (German: Verkäuferdarlehen) denotes an arrangement in a company acquisition under which the seller does not receive part of the purchase price at completion (closing, the transfer of the company against payment). The seller defers it for the buyer, that is, postpones the due date, or leaves the amount with the buyer as a loan. The buyer repays this portion with interest over an agreed term. Economically, the seller thereby finances part of the sale itself. The pattern is familiar from real estate: the seller of a house extends credit to the buyer for part of the price for several years because the bank does not finance the full amount.

Vendor loans occur above all in business succession, and also in a management buy-out, the purchase by the company's own management, and in a management buy-in, the purchase by external managers. What these cases have in common is that the buyer cannot raise the purchase price entirely from equity and bank loans. In addition to buyer and seller, the financing banks are involved, and they help determine the ranking of the loan. It is regulated in the company purchase agreement or in a separate loan agreement, supplemented by an agreement with the banks on ranking and payments.

Legal structure: deferral or loan

Two routes are open in law. With a deferral, the purchase price claim remains in place and only its due date is postponed. With conversion into a loan, the parties agree that the buyer owes the amount as a loan going forward; the rules on the monetary loan agreement then apply (Sections 488 et seq. of the German Civil Code, BGB). The difference affects, for example, rights of termination, defences arising from the purchase agreement and the tax treatment of a later default.

Since the seller no longer has any influence on the company after completion, the seller usually agrees information rights, for example receipt of the annual financial statements and interim figures. Rights of termination are also usual in the event of payment default, a resale of the company or a change of control at the buyer.

Subordination to bank financing

Banks that finance a company acquisition regularly require that the vendor loan ranks behind their claims and thus becomes a subordinated liability. This is done in a subordination or creditor agreement (intercreditor agreement). It provides that interest and repayment flow to the seller only as long as the bank receives its payments and the agreed financial ratios (covenants) are met. In it, the seller also undertakes not to call its claim due or enforce it in the event of disruption without the bank's consent.

This agreement mainly regulates the relationship between bank and seller. If the claim is also to rank behind the claims of all other creditors in insolvency proceedings of the buyer, an additional subordination agreement (Rangrücktritt) with the buyer is required (Section 39(2) of the German Insolvency Code, InsO).

Because a subordinated, long-term vendor loan ranks behind their claims in the worst case, banks often treat it as economic equity. For the seller, the subordination means that in a crisis the seller is satisfied only after the bank.

If the seller also holds a reinvestment stake in the acquirer, its loan may count as a shareholder loan. In an insolvency of the acquirer it is then subordinated by operation of law (Section 39(1) no. 5 InsO), unless an exception applies. The most important is the small shareholder exemption in Section 39(5) InsO for shareholders who are not managing directors and hold no more than 10%. In addition, the insolvency administrator can challenge repayments made in the last year before the insolvency filing and reclaim them (Section 135(1) no. 2 InsO). For collateral that the acquirer has provided for such a loan, this applies within ten years before the filing (Section 135(1) no. 1 InsO).

Collateral for the vendor loan

Without collateral, the seller has only an unsecured, subordinated claim in the event of default. A pledge of the sold shares to the seller, ranking after the bank's pledge, is therefore common. The pledging of GmbH shares (shares in a German limited liability company) follows the form of assignment and must be notarially recorded (Section 1274(1) BGB, Section 15(3) of the German Limited Liability Companies Act, GmbHG). Personal guarantees from the buyers, for example the managers in a management buy-out, and negative pledges, in which the buyer undertakes not to create any further encumbrances, are also possible.

Collateral from the assets of the sold company for liabilities of the buyer is possible only to a limited extent, because it runs up against the limits of capital maintenance (Section 30 GmbHG). An assignment of the shares subject to the condition precedent of full payment, comparable to a retention of title, is usually ruled out in the case of bank financing, because the bank demands the shares as first-ranking collateral.

Interest, repayment and taxes

Because of the subordination and the higher default risk, interest is generally above that on the bank financing. It can be paid currently or added to the loan and settled with the principal at the end. Repayment often begins only after a few years free of repayment or is made as a single payment at maturity, because the bank first wants to see its own loan repaid. The term therefore often extends beyond that of the bank financing.

For tax purposes, the deferred portion in principle forms part of the sale price in the seller's hands in the year of the sale, even though it is paid only later. If a deferred purchase price bears no interest or interest clearly below market level, an interest component may be carved out. For a private seller, current interest is income from capital assets. The flat tax rate of 25% does not apply under Section 32d(2) no. 1 of the German Income Tax Act (EStG), among other cases, if the seller is closely related to the buyer. The same applies if the seller holds at least 10% in an acquiring company.

Worked example: vendor loan in a business succession

A managing director takes over the founder's company as part of a succession for EUR 4.5 million. He contributes EUR 0.9 million of equity, and a bank finances EUR 2.7 million. The seller provides the remaining EUR 0.9 million as a subordinated loan at 6% interest, with a five-year term, two years free of repayment and then three equal annual instalments.

• Payment to the seller at closing: EUR 4.5 million minus EUR 0.9 million = EUR 3.6 million
• Interest in years 1 to 3 on EUR 900,000: EUR 54,000 each year, EUR 162,000 in total
• Repayment at the end of years 3, 4 and 5: EUR 300,000 each
• Interest in year 4 on EUR 600,000: EUR 36,000; in year 5 on EUR 300,000: EUR 18,000
• Total interest: EUR 162,000 plus EUR 36,000 plus EUR 18,000 = EUR 216,000
• From the bank's perspective: equity and subordinated vendor loan together EUR 1.8 million, that is, 40% of the purchase price

Over the term the seller receives EUR 4.5 million of purchase price and EUR 216,000 of interest, but bears the risk on EUR 0.9 million for five years. If the company misses the ratios agreed with the bank in year 3, the subordination agreement blocks repayment to the seller until the values are reached again. Whether 6% interest adequately compensates this risk is shown only by an examination of the debt service capacity in the conservative planning case. It shows whether current cash flow can carry interest and repayment for bank and seller.

Distinctions: vendor loan, earn-out and reinvestment

• Earn-out: The amount of this portion of the purchase price depends on future performance. With a vendor loan, the amount is fixed; what is uncertain is only whether the buyer can pay.
• Reinvestment: The seller remains a shareholder in the acquirer with part of the proceeds and bears equity risk with a corresponding opportunity instead of a fixed interest rate.
• Escrow account: secures the buyer's claims with a portion of the purchase price held on deposit; the vendor loan, by contrast, serves to finance the buyer.
• Subordinated loan from a third party: Mezzanine providers, whose capital sits between equity and debt, and other capital providers supply subordinated capital in return for higher remuneration. The vendor loan, by contrast, comes from the seller itself and is part of the purchase price agreement.

Common mistakes

• Set-off not regulated. If the buyer may offset warranty claims against the instalments at will, the loan becomes a security retention without the protective mechanisms of an escrow account.
• No security. Without a pledge of shares, the seller stands as a subordinated, unsecured creditor in the event of default.
• Unlimited payment block. A subordination agreement with no time limit on standstill and payment blocks leaves open when the seller receives its money.
• Missing information rights. Anyone who is a creditor for years needs regular figures in order to recognise risks in good time.
• Share too high. If the seller defers a large part of the purchase price, the seller has economically refinanced rather than sold.

Frequently asked questions

How large is a vendor loan usually?

As a rule of thumb, 10% to 30% of the purchase price. Considerably higher shares raise the question of whether the buyer can carry the transaction on its own strength.

What interest rate applies to a vendor loan?

There is no prescribed interest rate; the parties agree it freely. Because of the subordination, it is generally above the interest on the bank financing. An interest-free loan is legally possible but has tax consequences for the allocation between purchase price and interest.

What happens if the buyer does not pay?

That depends on the collateral and the subordination agreement. If a pledge of shares has been agreed, the seller can, within the arrangements with the bank, have recourse to the shares. Without collateral, the seller is left with a subordinated claim that ranks behind the bank in an insolvency of the buyer.

What belongs in the contract on a vendor loan?

At least amount, interest, term and repayment schedule, together with collateral, ranking in relation to the bank, rights of termination and information, and a rule on set-off against warranty claims. A general template does not replace this coordination, because the subordination agreement of the financing bank sets the room for manoeuvre.

Can the buyer offset warranty claims against the vendor loan?

Without a contractual rule, in principle yes, provided the claims are mutually capable of set-off (Section 387 BGB). Sellers therefore often permit set-off only against undisputed claims or claims established by a final court decision.

Are there vendor loans for real estate and within the family too?

Yes. In the sale of a property too, for example from parents to a child, the seller can defer part of the price. For tax purposes, such a contract between relatives is recognised only if it is structured as between third parties and actually carried out, that is, if interest and repayment really flow. On death, the seller's claim passes to the heirs.

The Roemer Capital view

In succession mandates, the vendor loan often decides whether a buyer can put the financing together. Before the seller agrees to a deferral, we therefore work through the debt service on the bank loan and the vendor loan in the financial model over the entire term, in the base case as well as in the conservative case.

From the seller's perspective, the loan is a credit extended to a debtor whose business the seller no longer controls. We therefore help negotiate ranking, collateral, information rights and set-off limits so that they match the risk that persists for years. The contracts with buyer and bank are drafted by the client's law firm, and the tax treatment is clarified by its tax adviser.