The vendor take-back (VTB) loan is often the piece that holds an SME transaction together. The bank doesn't finance everything, the buyer doesn't have the entire down payment, and the seller wants to get their price. Therefore, the seller agrees to be paid partially later, with interest.

This deferred amount is not a detail to be settled at the notary’s office the day before signing. It is a loan, granted by someone who will no longer be at the helm of the company, to someone who has just taken control of it. Its amount, rate, duration, guarantees, and rank relative to the bank determine what the seller will actually receive and the room for maneuver the buyer will have.

This guide is intended for SME owners selling and buyers taking over in Quebec. It assumes you are already familiar with the principle of a vendor take-back loan. For a basic definition, first consult Vendor take-back loan: definition, how it works, and its key role in business acquisitions.

Summary response: to negotiate a vendor take-back loan, first establish what each party is looking to protect, then set an amount that the company's cash flow can repay in addition to the bank debt. Next, negotiate in this order: the rate, the schedule and moratorium, the subordination conditions required by the bank, the guarantees, the default and information clauses, and finally, the tax implications. Record everything in the letter of intent, before due diligence.

What a vendor take-back loan is, and what it is not

A vendor take-back loan (also called a vendor credit or seller loan) is the portion of the price that the buyer does not pay at closing and that they commit to repay according to an agreed-upon schedule. The amount is fixed: it does not depend on the future performance of the business.

It is distinct from two mechanisms often confused with it:

• Earn-out: a portion of the price is paid only if the company reaches certain results after the sale. The amount is uncertain. See Everything you need to know about earn-outs.

• Holdback: a sum paid by the buyer, but kept in escrow (often with the notary or lawyer) to cover potential claims related to the seller's representations and warranties.

A single transaction can combine all three. Each is negotiated separately, but they interact: a seller who accepts a large vendor take-back loan will rarely also accept a large earn-out.

According to the BDC, seller financing typically accounts for 10% to 15% of a transaction amount, repayable over three to five years, with payments often deferred in the first year. In practice, we see VTB loans of 10% to 30% of the price in Quebec SMEs, and sometimes more in transfers to family or employees.

Step 1: Clarify what each party is looking to protect

A VTB loan negotiation rarely fails because of the interest rate. It fails because each party is defending an interest they have not named.

What the seller wants to protect

• The price: they agree to wait for part of their money, but they want the total price to remain intact.

• The payment: they fear that the business will decline under the new owner and the loan will never be repaid.

• Their tax position: a well-structured loan allows for the spreading of capital gains taxation (see Step 8).

• Their exit: they do not want to remain tied to the business for seven years.

What the buyer wants to protect

• Their liquidity during the first few years, a period when there are many unforeseen events.

• Their bank financing: the VTB loan reduces the amount to be borrowed and reassures the bank.

• Recourse: if the seller has hidden a problem, the buyer wants to be able to withhold payments.

What the bank requires

The bank is not at the table, but it often has the final say. It will require its loan to have priority and the VTB loan to be subordinated to it. It will also limit payments to the seller when the company does not meet its ratios.

Tip: before the first meeting, write down in one sentence what you cannot give up. For a seller, for example: "I want to be paid in full in five years, with security on the assets." For a buyer: "I cannot repay the seller anything during the first 12 months." These two sentences will guide everything that follows.

Step 2: Set an amount the company can repay

The amount of the VTB loan is not decided based on what the buyer lacks to complete their financing package. It is decided based on what the company can repay, in addition to its bank debt, without being suffocated.

The question to ask: what cash flow is left for debt?

Start with the company's normalized EBITDA. Subtract taxes, maintenance capital expenditures (equipment replacement, vehicles), and a reasonable salary for the new owner. What remains is the cash flow available to repay all debts, including the seller's loan.

Banks compare this cash flow to the total principal and interest payments. The resulting ratio, often called the debt service coverage ratio, must generally exceed a threshold set by the lender (often around 1.25, depending on the lenders and sectors). Below this threshold, the bank reduces its loan or requires a larger down payment.

Numbered example: Plomberie Laurentides inc.

A plumbing contractor in Saint-Jérôme is selling the shares of his company for $1,500,000, which is about four times a normalized EBITDA of $375,000. After taxes, maintenance investments, and the new owner's salary, about $280,000 per year remains for debt.

Financing package proposed by the buyer:

If the loan is interest-only for the first year, then amortized over 4 years:

• Year 1: approximately $163,000 to the bank and $22,500 in interest to the seller, for a total of $185,500. The ratio is about 1.5: comfortable.

• Years 2 to 5: approximately $163,000 to the bank and $105,700 to the seller, for a total of $268,700. The ratio falls to about 1.04: one bad year and the company can no longer pay everyone.

Two levers can correct this without changing the price:

• amortize the loan over 5 years after the moratorium (about $87,000 per year) rather than 4;

• obtain a 10-year amortization from the bank rather than 7 (about $125,400 per year).

With both adjustments, the total debt service drops to about $212,400 per year and the ratio rises back to about 1.32. The seller is paid more slowly, but they are paid.

Takeaway: it is in the seller's interest to perform this calculation themselves. A loan that is too heavy is not a more advantageous loan; it is a riskier one. The EBITDA calculator by TRNSFR helps establish the starting point.

Where does the loan fit into the price?

A buyer may be tempted to offer a higher price in exchange for a larger loan or a lower rate. This is sometimes a good compromise, but the seller must compare offers on a comparable basis: what the total payments are worth today, considering the risk. An offer of $1,600,000 with 40% payable over seven years at 3% may be worth less than an offer of $1,450,000 paid almost entirely at closing.

Step 3: Negotiate the interest rate

The rate compensates the seller for time and risk. However, this risk is high: their claim ranks behind the bank's, and they no longer control the company. A rate lower than the bank loan rate is therefore difficult to justify financially, even if it is common in practice.

Benchmarks used

• The primary bank loan rate, which the VTB loan should, in principle, equal or exceed.

• The prime rate plus a premium, a simple formula that follows rate fluctuations.

• A fixed rate for the entire term, which provides predictability for both parties.

• A graduated rate, lower at the start and then increasing, which helps the buyer during their first years.

In SME transactions, rates of 3% to 8% are often observed. The right rate depends on the seniority of the claim, the guarantees offered, and the duration: the longer, more subordinated, and less secured the loan, the higher the rate should be.

The rate as a bargaining chip

The rate is rarely negotiated alone. It is often used to offset another concession:

• the buyer obtains a one-year moratorium: the seller asks for one percentage point more;

• the seller obtains a personal guarantee from the buyer: they accept a lower rate;

• the buyer wants a 0% rate: the seller asks for a higher price or a shorter schedule.

Trap to avoid: an poorly expressed rate

The (federal) Interest Act stipulates that when a rate is stated for a period of less than one year (for example, a monthly rate), only 5% interest per year can be claimed if the contract does not expressly state the equivalent annual rate. Always express the rate on an annual basis in the agreement, and specify the compounding frequency.

Also provide for a rate on arrears: interest on a late payment, ideally slightly higher than the base rate to encourage the buyer to pay on time.

Step 4: Build the repayment schedule

Duration

Three to five years is the most common duration. Beyond that, the seller remains exposed for a long time to a business they no longer control, and the bank often requires its own loan to be repaid first. A longer duration may be justified in a transfer to family or employees.

Moratorium

A moratorium of 6 to 12 months (no principal repayment, sometimes no interest either) gives the buyer breathing room during the transition. Specify whether this is a moratorium on principal only or on principal and interest. In the latter case, indicate whether interest accrues and when it will be paid.

Structure of payments

• Equal payments (principal and interest): predictable, easy to integrate into the budget.

• Equal principal plus interest: higher payments at the beginning, which decrease later. The seller recovers their principal faster.

• Balloon payment: small payments, then a large balance at the end. This is risky for the seller, because it all rests on the buyer’s ability to refinance.

• Seasonal payments: useful for a company whose income is concentrated in a few months (landscaping, outfitting, construction).

Prepayment

The buyer will want to be able to prepay, without penalty, when they refinance or have surpluses. The seller rarely has a good reason to refuse, unless they are counting on spreading payments for tax reasons. In that case, negotiate a notice period or a minimum amount per prepayment.

Step 5: Negotiate with the primary lender before signing

This is the step most often forgotten, and the one that causes the worst surprises. The seller negotiates a great VTB loan with the buyer, then discovers a few days before closing the subordination agreement that the bank is asking them to sign.

What the bank usually asks for

• Subordination: the seller's claim ranks behind the bank's. Under Quebec law, this is often done through a cession of rank on the security and a subordination agreement (also called post-position).

• Payment restrictions: the seller cannot receive payment if the company is in default to the bank or does not meet its financial ratios.

• A standstill period: even if the buyer is in default to them, the seller cannot exercise their remedies before a certain time or without the bank's consent.

• No changes without consent: the seller and buyer cannot change the schedule or rate without the lender's consent.

What the seller can negotiate

• receiving at least the interest, even when the principal is blocked;

• that blocked payments be deferred (not cancelled) and accrue interest;

• a standstill period limited in time (for example 120 or 180 days);

• a copy of default notices sent by the bank to the buyer;

• the right to pay off the bank to regain first priority, in extreme cases.

Tip: Request the lender's draft subordination agreement as soon as the buyer has their bank offer letter. Negotiating these points after closing is virtually impossible.

BDC and many banks view vendor financing favorably, as it demonstrates confidence in the business. Use this leverage: a seller who finances part of the price has real bargaining power over subordination terms. To understand the structures, see Financing the purchase of an SME in Quebec.

Step 6: Choose the security

A vendor take-back note without security relies entirely on the good faith and financial health of the buyer. Security does not replace a good buyer, but it changes the balance of power in the event of a problem.

Common types of security

• A movable hypothec on the business's assets (equipment, inventory, receivables, intellectual property). In Quebec, a business can hypothecate its movable property without surrendering possession to the creditor; the hypothec must be registered in the Register of Personal and Movable Real Rights (RDPRM) to be enforceable against third parties. It will usually be second-ranking, behind the bank's.

• A hypothec on the shares purchased, where the buyer has acquired the shares through a holding company. In the event of default, the seller can regain control of the business.

• Personal guarantee from the buyer (and sometimes their spouse or partners), which allows the seller to pursue the buyer's personal assets.

• Life insurance on the buyer, assigned as security to the seller. It covers the very real risk of the new owner's death during the term of the note.

• A hypothec on immovables (real estate) belonging to the business or the buyer, if any exist.

Adapting security to the structure

In an asset sale, the buyer is purchasing the actual assets: the seller can take a hypothec directly on those assets. In a share sale, the assets remain in the operating company: the seller must obtain a hypothec granted by that company, in addition to a hypothec on the shares held by the buyer's company. For the differences between the two structures, see Share sale or asset sale?.

Trap to avoid: Failing to register the hypothec or registering it with the wrong name of the grantor. An unregistered hypothec, or one registered under an incorrect name, may lose its rank to other creditors. It is the notary's or lawyer's role to ensure registration; verify that it has been done.

Step 7: Draft the clauses that will make the difference

Default and acceleration

The agreement must list the events of default: missed payment after a grace period, bankruptcy or insolvency, sale of the business or its principal assets without consent, default to the bank, false representations. In the event of default, the balance becomes due in full. The Civil Code of Quebec already provides that a debtor loses the benefit of the term in certain situations, notably if they become insolvent or reduce the security granted, but the agreement must specify other cases.

Provide a reasonable cure period (e.g., 15 or 30 days after written notice). A buyer acting in good faith who is a few days late should not lose their business; a buyer in genuine financial difficulty should not be able to delay the seller indefinitely.

Reporting obligations

The seller no longer has access to the books. They should obtain:

• annual financial statements within a set period after the end of the fiscal year;

• interim financial statements (e.g., quarterly) for as long as the balance remains unpaid;

• a copy of any notices of default received from the bank;

• notice of any significant litigation.

Restrictions during the term of the balance

For as long as the balance remains unpaid, the seller may request that the buyer not be able to, without their consent:

• pay dividends or bonuses above a certain threshold;

• substantially increase their own salary;

• sell significant assets or the business itself;

• incur new debt above a certain threshold;

• relocate the business outside a given region.

These restrictions must remain reasonable. If they prevent the buyer from managing their business, they will refuse them—and rightly so.

Right of set-off: the most disputed point

The buyer will want to be able to deduct from the balance payments any amount the seller owes them due to a false representation or a breached warranty (e.g., an undisclosed tax liability discovered after closing). For the buyer, the balance is the simplest way to get paid.

The seller, meanwhile, fears that the buyer will cite a questionable claim to stop paying. Possible compromises:

• limit set-off to claims established by judgment or acknowledged in writing by the seller;

• require detailed notice and provide the seller with time to contest;

• place the withheld amounts into an escrow account held by a third party until the dispute is resolved, rather than keeping them within the business;

• limit set-off to a maximum amount or a specific period.

Resale of the business by the buyer

If the buyer resells the business before having paid off the balance, the seller will want to be paid in full at the closing of that resale. This clause is simple and rarely contested; it must still be put in writing.

Step 8: Integrate tax considerations before signing

Taxation should not dictate the structure of the balance, but it can significantly change what the seller keeps. Have the consequences validated by a CPA or tax specialist before signing the letter of intent.

For the seller: Capital gains reserve

When the price is not entirely payable in the year of sale, the seller can generally claim a reserve that defers the taxation of a portion of the capital gain to subsequent years. As a general rule, the reserve allows the gain to be spread over a maximum of five years: at least 20% of the gain must be included each year, cumulatively. Federally, the reserve is calculated using form T2017. The Quebec regime is harmonized: the reserve amount must be the same on both returns.

The period is extended to ten years (at least 10% of the gain included each year) in certain cases, such as the sale to a child of qualified small business corporation shares and, as of 2024, certain qualifying intergenerational transfers and sales to an employee ownership trust.

The reserve is not available in certain situations, for example, if the seller is selling to a corporation they control.

Example: The five-year limit in practice

Let's take Plomberie Laurentides again. The seller has a cost base of $100,000 for their shares and realizes a gain of $1,400,000. The $375,000 balance represents 25% of the price. Assume a sale at the beginning of the year, a 12-month moratorium, then amortization over 5 years (without considering the capital gains exemption or the fact that exact amounts depend on the closing date and selling costs).

In year 5, the remaining gain must be included in full, even if about $84,000 of the balance remains to be received. The seller therefore pays tax on a sum they have not yet collected. A schedule exceeding five years may be justified, but the seller must plan for the cash flow to pay this tax.

Coordinating with the capital gains exemption

If the shares qualify as qualified small business corporation shares, the seller may be able to shelter a large part of their gain using the lifetime capital gains exemption. In this case, the reserve is less important. Both mechanisms can be combined, and the order in which they are used has consequences, notably on the alternative minimum tax. This is a question to be resolved with your CPA, not in the purchase agreement.

Interest

Interest received by the seller is taxable as investment income as it is earned. On the buyer's side, interest paid on an amount owed for the acquisition of property used to earn income from business or property, such as shares or business assets, is generally deductible. Have this confirmed based on your structure (e.g., purchase by a holding company).

A zero rate is not neutral

A 0% rate favors the buyer, but it may also lead tax authorities to question the fair market value of the price, especially between related parties. Between unrelated parties, it is primarily an economic question: the seller is essentially making a gift equal to the interest not collected.

Template: Vendor take-back note term sheet

Here is a structure to integrate into your letter of intent. It does not replace the agreement drafted by a notary or lawyer, but it prevents these points from being discovered at the last minute.

Amount: $[amount], representing [percentage]% of the purchase price.

Debtor: [name of buying company], with the personal guarantee of [name of buyer and, if applicable, other guarantors].

Interest rate: [rate]% per annum, calculated [monthly / annually] and not compounded. Interest on arrears: [rate]% per annum.

Moratorium: no principal repayments during the first [number] months following closing. Interest is [payable monthly / accrued and payable on (date)].

Repayment: [number] equal [monthly / quarterly] principal and interest installments of $[amount], starting on [date].

Prepayment: permitted at any time, without penalty, upon [number] days' notice.

Security: [rank]-ranking movable hypothec on all assets of [operating company], hypothec on the shares of [operating company] held by [buying company], personal guarantee of [name], assignment of life insurance on [name] for a minimum capital amount of $[amount].

Subordination: the balance will be subordinated to the financing of [name of lender] according to an agreement providing at a minimum for the payment of current interest and a maximum waiting period of [number] days.

Reporting: annual financial statements within [number] days after the end of the fiscal year and [quarterly] interim statements as long as the balance remains unpaid.

Restrictions: no dividends or shareholder remuneration exceeding $[amount] per year, and no sale of significant assets, without the written consent of the seller, which shall not be unreasonably withheld.

Events of default: failure to pay not cured within [number] days of written notice, insolvency, default to the senior lender, sale of the business, material false representation.

Set-off: permitted only for claims acknowledged in writing by the seller or established by judgment; contested amounts are placed in escrow with [notary / lawyer] until resolution.

Acceleration upon resale: the balance becomes due in full upon the closing of any sale of the majority of shares or substantially all assets.

This template must be adapted to the transaction structure and reviewed by your legal and tax advisors. TRNSFR also offers a letter of intent template and a negotiation preparation checklist.

Complete example: Negotiating a balance for a restaurant in Sherbrooke

A restaurateur sells her restaurant's assets (equipment, lease, goodwill, brand) for $600,000 to a couple of experienced restaurateurs. The bank agrees to finance $330,000. The couple has $90,000. They are short $180,000, or 30% of the price.

What unlocked the negotiation: the seller understood that the moratorium was essential for the buyer during the planned renovations, and the buyer understood that the seller mainly wanted to receive a regular income. Paying interest from the first month addressed both needs.

The most frequent pitfalls

• Negotiating the balance after due diligence. At this stage, fatigue and the closing deadline push you to accept anything. Set the main terms in the letter of intent.

• Forgetting the bank. Discovering the subordination agreement the week of closing is the most common cause of frustration among sellers.

• Confusing a balance with a conditional payment. If payment depends on results, it is no longer a vendor take-back, and the tax implications and recourse are different.

• A balance that fills a funding gap. If the balance is used to compensate for an excessively high price that the company cannot finance, the problem is the price, not the balance.

• Poorly registered guarantees. A hypothec not registered at the RDPRM does not protect the seller against other creditors.

• Ignoring the five-year tax limit. A seven-year balance may force the seller to pay tax before being paid.

• No disclosure obligation. A seller who does not receive financial statements discovers difficulties only when payments cease.

• Unlimited set-off. It turns any difference of opinion into a payment stoppage.

For other common errors, see The 5 most frequent errors during a business transfer in Quebec.

Can you negotiate a vendor take-back yourself?

Yes, the main points: the amount, the rate, the term, the moratorium, and the desired guarantees. These are business decisions. The seller and the buyer know them better than anyone, and settling them directly often avoids months of back-and-forth between advisors.

The drafting of the agreement, the security interests, and their registration must, however, be entrusted to a notary or lawyer. Also, consult a CPA or tax specialist before signing the letter of intent to verify the capital gains reserve, the exemption, and the deductibility of interest. If the bank requires a subordination agreement, have it reviewed by your own advisor: it protects the lender, not you. To better understand the role of each, see The role of the notary in a business transaction.

For the entire sales process, consult The ultimate guide to selling a business. For the buyer's perspective, see The ultimate guide to buying a business.

Sources

• Canada Revenue Agency, Claiming a capital gains reserve

• Ministère des Finances du Québec, Tax expenditures: ten-year capital gains reserve for the sale of small business corporation shares to children

• Revenu Québec, Capital Gains and Losses (IN-120)

• CPA Canada, Business transfers to family members and employees: new tax rules applicable starting in 2024

• BDC, Facilitate your acquisition with vendor financing

• BDC, How to finance the sale of your business

• Justice Canada, Interest Act (R.S.C., 1985, c. I-15)

• LégisQuébec, Civil Code of Quebec

• Register of Personal and Movable Real Rights (RDPRM)

This article provides general information and does not replace legal, tax, or financial analysis adapted to your transaction.