What Is a Vendor Note?

What Is a Vendor Note?

Let me explain what a vendor note is—it's a short-term loan that a vendor provides to a customer, secured by the goods you're buying from that vendor. You can think of it as a type of vendor finance or vendor financing, which usually comes as a deferred loan from the vendor. Vendors often use this when they have more confidence in your business prospects than a traditional bank would.

Key Takeaways

To break it down, a vendor note is a short-term loan from a seller to you, the customer, backed by the products you're purchasing. This setup is a deferred loan, commonly used when your company can't get the capital it needs from traditional lenders. These loans have higher default rates than bank loans, so they come with higher interest to cover the vendor's risk. They're often secured by the inventory you're buying, but could also involve your business assets or cash flow. Maturity periods vary, but three to five years is typical.

Understanding Vendor Notes

Vendor notes can be a practical financing option, especially if you're a smaller buyer dealing with an established vendor who has a wide customer base. You might have limited working capital for inventory or essential goods, and in some cases, you could be completely reliant on this financing to get what you need. For the vendor, it helps boost sales and revenue, though it carries the risk that you won't repay the loan. These notes are usually secured by the inventory, but pledges on your assets or cash flow can back them too. Overall, using a vendor note signals a solid relationship between you and the vendor.

Terms of Vendor Notes

Vendor notes differ in maturity times, but three to five years is common. You might see various terms built in, like limits on your business practices, restrictions on acquiring other inventory or assets, or requirements to maintain certain financial ratios. While they're often deferred loans, sometimes there's an interest charge on the borrowed amount, which is the value of the goods exchanged. Vendors prefer immediate payment, but financing you and getting repaid over time—possibly with interest—is better than losing the sale.

Advantages and Disadvantages of Vendor Notes

Depending on the inventory or equipment you're eyeing, vendor notes have pros and cons—you need to compare them to a traditional bank loan to see what's best for your business. One key advantage is getting equipment at a good value; many vendors have in-house financing that offers discounts since everything comes directly from the manufacturer, which can beat deals elsewhere. It's also straightforward to get both the purchase and financing at once—the vendor wants the sale and knows the product, unlike a bank that has to assess everything, making the process longer.

Financing from the vendor often means lower upfront costs and easier equipment updates since you're dealing directly with them. On the downside, if the vendor lacks in-house financing and you go through a third-party, they might not know the equipment well and could charge higher interest or finance less of the cost. Buying used equipment can be pricier too, as manufacturer incentives don't apply, and the vendor factors that in. Some vendors only finance the equipment itself, skipping coverage for things like transportation or training.

Example of a Vendor Note

Consider this scenario: You're starting a new medical office and need a $1,000,000 laser device for outpatient surgeries, but you only have $100,000. Instead of approaching a bank, the medical device vendor offers the equipment with you paying back the $900,000 over five years at 2% interest. The vendor holds the note until it's repaid. You get the device to generate revenue, the vendor makes the sale, earns interest, and might get more business from you later.

What Is Vendor Financing?

Vendor financing is when you get funding directly from the vendor for buying inventory or equipment, unlike traditional bank loans. It's often a deferred loan that can strengthen your relationship with the vendor.

Are Vendor Notes Subordinated Debt?

Yes, vendor notes are subordinated debt—they rank below senior debt in repayment during bankruptcy, so senior debt holders get paid first.

What Is a Vendor Loan Agreement?

A vendor loan agreement is the contract between you and the vendor where they provide capital for their product. You pay an upfront amount, then the rest plus interest over time. It details the parties, financed amount, maturity, and interest rate.

What Happens If You Default on a Vendor Note?

If you default, consequences depend on the agreement—the vendor might repossess the inventory or equipment, or other assets, and could claim your future cash flows to recover losses.

The Bottom Line

A vendor note can work well if you're seeking inventory or equipment, especially as a new business without much cash or credit for a bank loan. It builds a potentially profitable relationship for both sides. Decide between this and a bank loan based on what's right for you— weigh the pros and cons carefully before committing.