1. Introduction: What do we mean by “Vendor Loan”
The use of vendor loans or vendor financing in Common Law contexts is becoming increasingly popular in M&A transactions. This is due to its ability to counteract rising interest rates associated with regular loans and its effectiveness in regulating agreements between shareholders.
A vendor loan is a legal arrangement that is used when the seller of a particular product or service is also the lender to the buyer/borrower. The borrower takes the loan to cover all the costs associated with the purchase of the product or service offered by the vendor, who, for the purpose of the transaction, also serves as the lender.
During these operations, the financing amount is then used to compulsorily acquire stakes or quotas in the seller’s business. This type of juridical tool has been recently employed in operations such as merger-leveraged buy-outs.
Some key aspects that are typically common in vendor loans include subordination to other financing agreements entered into with banks, which the buyer procures to support the transaction. Hence, the seller will obtain the repayment of the financing upon the full repayment of the senior note obtained through the banking system to support the operation, except for specific instances (such as early repayment of the senior financing, sale of the company to a third party, listings in regulated markets or other events expressly provided for in the agreement). The capitalization of interests (PIK interests) and its deferred repayment in a single due date (so-called bullet payment) are other key aspects of vendor loans.
These agreements tend to occur in situations, where a vendor perceives a higher value in a customer's business compared to what a traditional lending institution does.
Although it is not an ideal situation for the vendor to provide products or services without immediate payment, they find it better than not making a sale at all. The vendor earns interest on the deferred payments and gains a competitive edge over their competitors by offering vendor financing programs. This section of the vendor's business is referred to as an investment center and is regularly evaluated to ensure it is profitable.
1.1 How are Vendor Loan arrangements structured?
Vendor loans can be structured using either debt or equity instruments. In debt vendor financing, the borrower agrees to pay a specific price for inventory along with an agreed-upon interest charge. The sum is either repaid over time or written off as a bad debt on the vendor's books. On the other hand, with equity vendor financing, the vendor can provide goods in exchange for an agreed-upon amount of the borrower’s company stock.
Equity vendor financing is more frequently used in startup businesses, which utilize a form of vendor-supplied financing known as "inventory financing." This financing method uses inventory as collateral to secure lines of credit or short-term loans.
Vendor financing can also be used when an individual lacks the capital required to buy a business outright. A vendor may rely on the sales it makes to a particular business to achieve financial targets. By providing financing in the form of a loan, it can secure that business while strengthening its relationship with the business owner to ensure long-term success.
1.2 Normative Regulation
Vendor Loans are not expressly regulated under any Italian provision, hence they do not have any specific regulation. As such, their discipline is mostly developed through commercial uses, praxis and general principles of law pertaining to corporate law and general rules on contracts and obligations, (Book 4, Title II and III Italian Civil Code).
Vendor financing lacks regulation also within the UK and US regulatory frameworks, and it rather falls under the scope of broader financial and commercial laws. In the UK, Vendor financing is primarily regulated under rules in the Consumer Credit Act 1974 and the Companies Act 2006.
In the US, vendor financing is subject to various federal and state laws depending on the nature of the transaction, alternatively through the “Truth in Lending Act”, the “Uniform Commercial Code”, the Securities and Exchange Commission (SEC) Regulations or Specific State Laws.
1.3 Earn-outs
Another contractual bond that is used for similar purposes is earn-out. Earn-outs condition the repayment upon future and uncertain events, based on the future performance by the company. Through this tool, there is a degree of risk sharing between the vendor and the buyer, and an incentive for a contractual bond for the management of the vendor to continue operations to grant as high profits and exits to the vendor as possible.
However, there are some inherent risks to these operations and they include manipulation of the parameters on behalf of the buyer, to minimize the price upon high performance, and other issues that could arise from the uncertainty of the employed parameters, which ought to be as objective as possible.
This tool, such as vendor loans, provide for a relationship between the seller and the buyer and should ideally unify their aims allowing for maximized performance in the future.
2. Benefits for the involved parties
As anticipated, by signing a vendor financing agreement, the vendor commits to selling to the buyer, relieving the latter from the immediate obligation to pay the full purchase price upfront. This arrangement serves as an alternative financing option for individuals or entities who may not meet the stringent criteria for traditional bank loans. Nonetheless, the effectiveness of this agreement relies on the establishment of a fiduciary relationship, particularly the vendor’s reliance on the buyer’s capacity to repay the loan along with interest. There are several benefits that this type of arrangement entails, some of which are general, and some others refer specifically either to the buyer or to the vendor.
The primary advantage of this arrangement is its inherent flexibility, enabling the fulfillment of a company's specific requirements in a customized manner and allowing for greater negotiation latitude. Obtaining financing from traditional sources can be a time-consuming process. Consequently, this form of creative financing expedites the process, neutralizing such issues.
Shifting our focus to the buyer’s perspective, entering into a vendor financing agreement presents three key benefits:
Lower exposure to the banking system: this arrangement allows an avoidance of all the stringent credit requirements imposed by banks in order to access credit.
Seller Involvement: by investing part of the purchase price in the acquired company, buyers ensure active participation of the selling shareholders. This involvement is often driven by their expertise, skills, and specific knowledge, creating an economic bond that complements the obligations arising from the transaction, and this fosters business continuity.
Negotiation Flexibility: the buyer enjoys greater flexibility in negotiating the terms of the agreement with the seller. Vendor financing transactions tend to be quicker and involve less paperwork than traditional loan/mortgage processes, particularly in real estate transactions.
Attractive Interest Rates: Sellers may offer more favorable interest rates than those available through traditional mortgages. On the other hand, examining the vendor’s perspective, there are several advantages to offering vendor financing:
Expanded Buyer Pool: vendor financing can attract a broader range of potential buyers, including those who may not qualify for traditional financing.
Certainty of Payment: it provides a method of postponed payment that is precise and certain, unlike other forms used in similar transactions, such as earn-outs (which link payment to the occurrence of future and uncertain events, such as achieving specific company goals) or holdbacks (where sums are retained as a precaution for price adjustment mechanisms or seller representations and warranties). Sellersreceive regular payments, ensuring a steady income stream.
Expedited Sales: vendor loans can expedite the sale of a property, particularly in slower market conditions (such as real estate), by making the purchase more attractive to buyers.
3. Inherent risks: what happens in case of failure to pay the price?
As with any financial arrangement, there are some inherent risks associated with vendor loans that must be carefully considered and managed.
On a general level, vendor finance agreements can be legally complex and require careful drafting to protect the rights and interests of both parties. If we consider real estate properties being sold through this form of financing, if the market is subject to volatility, the property’s value may fluctuate during the agreement, affecting both parties’ interests. Furthermore, there can be higher interest rates, compared to bank loans. However, such rates can be negotiated between the buyer and the vendor, therefore the vendor could agree on much lower rates. Lastly, In the event of default on payments, buyers could risk losing the property through repossession, along with any payments made.
To avoid any inconvenience and limit the risks, some contractual precautions can be adopted.Being a legally binding contract that outlines the terms and conditions of the transaction, the vendor financing agreement should include, among the others, the following key elements:
● Default provisions: the actions to be taken if either party fails to fulfill their obligations under the agreement.
● Rights and liabilities: the rights and responsibilities of both the buyer and the seller during the term of the agreement.
● Termination clauses: Conditions under which either party can terminate the agreement.
As we will explore in more detail below, the case of AC Milan serves as a prime example of one of the numerous risks associated with this type of transaction. The prosecutors have scrutinized the company’s shareholder structure due to various suspicions regarding the true beneficiaries of the ownership interests.
4. AC Milan: a vendor loan case
As anticipated, a spotlight case, which has emerged in newspapers recently, concerns the sale of shares in the Italian football mogul AC Milan, which were sold on August 31st, 2022, by Elliot Management to Redbird Capital through a vendor loan. Details from this transaction came to surface through the financial statements dated June 30th, 2023, of the “Rossoneri Sport Investment Luxembourg”, the vehicle company used by Elliott to provide the financing to ACM Bidco, the vehicle company used by RedBird as part of the operation that led to the purchase of the Rossoneri.
As of August 31st, 2022, Rossoneri Sport Investment entered into a loan agreement with ACM BIDCO BV for a principal amount of EUR 560,000,000.00, with an interest rate of 8%, expiring on the third anniversary of the closing date.
On January 27th, 2023, Rossoneri Sport Investment Lux completed a financial transaction by transferring 95.73% of its rights and ownership in a vendor loan, valued at around EUR 526.5 million, to Project Redblack Sarl. This transaction was carried out as a payment in-kind, according to the terms outlined in an assignment agreement between the two entities.
Blue Skye Financial Partners, who owns the remaining 4.27% of the loan, did not transfer to Project Redblack. This 4.27% represents their stake in the control chain of the Milan football club, which has been at the center of multiple legal disputes. There have been 11 cases filed related to the club’s sale across three jurisdictions: Italy, Luxembourg, and the United States. One of these cases triggered the launch of a formal investigation (in Italy).
The disputes escalated when Elliott Management, operating through Elliott's partner and part of the club's ownership chain, filed a private criminal indictment in Luxembourg. This legal move, known as a ‘citation directe,’ targeted representatives from Blue Skye Financial Partners. Elliott accused them of engaging in criminal activities, including blackmail, extortion, and fraudulent misrepresentation, in an attempt to challenge the legality of the club's sale.
Later in the year, on July 26th, 2023, Rossoneri Sport Investment Lux entered into an 'AFA agreement' with Project Redblack Sarl, acting as the lender. The agreement aimed to correct and rectify certain sums that had been previously repaid under the terms of the original financial arrangements, with retroactive effect from January 27th, 2023.
On August 28th, 2023, Project Redblack Sarl confirmed in writing that it would not require any payment or reimbursement of sums related to the Financial Documents or the AFA Financial Documents before June 30th, 2025. It was also specified that no interest or default interest would accrue on these amounts until that date.
The financial and legal conflicts surrounding the sale of the Milan football club and the associated financial transactions are still ongoing. A new hearing is scheduled in the coming weeks to further address and potentially resolve these complex issues.
On the Italian playing field, this transaction is subjected to the investigation by the Milan Prosecutor’s Office, which sees Milan’s current CEO Giorgio Furlani and his predecessor, former CEO Ivan Gazidis under the microscope.
5. Conclusion
As outlined through the course of this paper, Vendor Loans are becoming an increasingly more popular legal tool when market conditions require operators to come up with innovative solutions to tackle issues such as high interest rates and difficulties in closing traditional financing arrangements with banking institutions.These operations could turn out to be highly beneficial for both the lender/seller and the borrower/buyer, if the possible adversities that may arise from these agreements are duly regulated. On the contrary, mishaps may occur, as the AC Milan case reported above goes to show, which might lead to unforeseeable disputes, infringing the efficiency of the operation.
Sources
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