What Is a Vendor Note?

A vendor note is a short-term loan a vendor makes to a customer that is secured by goods the customer buys from the vendor. A vendor note is classified as a form of "vendor finance" or "vendor financing," which is a type of lending that usually takes the form of a deferred loan made by a vendor. Vendor notes are most likely to be employed when a vendor has more confidence in a customer's business prospects than a traditional lender (a bank) would.

Key Takeaways

  • A vendor note is a short-term loan a seller makes to a customer that is backed up by products that the customer buys from the vendor.
  • This type of deal is called a deferred loan and is often used when a company is unable to borrow the amount of capital it wants from more traditional lenders.
  • These types of loans often have a higher rate of default than those offered by most banks, and therefore offer a higher rate of interest to compensate the vendors for the risk of defaulting on those loans.
  • Vendor notes vary in terms of the length of time before maturity, but typically it takes three to five years to reach total maturity.

Understanding Vendor Notes

Vendor notes can be a useful and convenient form of financing, particularly when well-established vendors with diverse customer bases are taking on new, smaller buyers who typically have small amounts of working capital with which to purchase inventory or essential goods.

In some cases, customers may be entirely dependent on vendor note financing to secure vital inventory or equipment. The use of such vendor financing can make it easier for a company to increase sales volume and revenue, but in doing so it also incurs the risk of the buyers it finances not paying back their loans. Vendor note loans are often secured by the inventory being sold to the buyer, but also may be backed by pledges of the buyer's business assets or cash flow. The use of a vendor note will generally denote a good relationship between vendor and customer.

Terms of Vendor Notes

Vendor notes vary in terms of their time to maturity, but notes with time horizons in the range of three to five years are considered common. Many different types of terms and conditions can be built into a vendor note, such as limitations on the types of business practices the buyer can engage in, restrictions on acquiring other inventory or business assets, and requirements that specific financial ratios or benchmarks be maintained.

While vendor notes tend to amount to deferred loans, sometimes there may be an interest charge on the borrowed sum (the value of goods that has changed hands). While vendors would doubtlessly prefer to be paid immediately for goods or services they render, maintaining a relationship by helping with financing and being paid back over time (sometimes with interest) is better than no sale at all.

Example of Vendor Note

A new medical office buyer wants to acquire a laser device used for special outpatient surgeries at a cost of $1,000,000. It has just $100,000 to spend. Rather than going to a lender to ask for a business loan, a medical device vendor will offer the piece of equipment to the customer under the agreement that the medical office buyer pays back the $900,000 balance of the medical device over a period of five years at an interest rate of 2%.

As such, the vendor will carry a note until the $900,000 is repaid. The buyer gets the device, which will add a revenue stream, the seller gets a sale and pockets the interest on the loan. It also may get follow-on business from the buyer.