Vendor Note: Meaning, Terms, Pros and Cons

Key takeaways

• A vendor note is a short- to medium-term loan a seller provides to a buyer to finance the purchase of the seller’s goods or equipment.
• These loans are usually secured by the purchased inventory or other business assets and commonly mature in about three to five years.
• Vendor notes are a form of vendor financing (debt financing) and are often subordinated to bank debt, carrying higher default risk and typically higher effective interest or implicit cost.

What is a vendor note?

A vendor note is a financing arrangement in which the seller (vendor) extends credit to the buyer for the purchase of inventory, equipment, or other goods. Instead of paying the full purchase price up front, the buyer repays the vendor over time under agreed terms. The vendor note may include an explicit interest rate or be structured as deferred payment with other economic trade-offs.

How vendor notes work

• Security: Vendor notes are commonly secured by the goods sold (inventory or equipment) and sometimes by other business assets or cash flow.
• Term: Typical maturity ranges from about three to five years, though terms can vary.
• Covenants and restrictions: Agreements often include covenants such as limits on certain business activities, requirements to maintain specified financial ratios, and restrictions on acquiring other assets.
• Interest and payment structure: Payments may include interest; vendors may offer lower or no interest in exchange for other concessions. Terms depend on the vendor’s risk tolerance and relationship with the buyer.

Vendor financing vs. equity financing

Vendor financing can be debt-based (vendor notes) or equity-based (the vendor takes ownership stakes). Vendor notes are debt instruments; the vendor remains a creditor rather than an owner.

Advantages

• Easier access to financing, especially for new or credit-limited businesses.
• Simultaneous purchase and financing — faster than arranging a bank loan.
• Potential discounts or manufacturer incentives when financing comes from the vendor.
• Lower upfront cash requirements and simpler paths to equipment upgrades through ongoing vendor relationships.

Disadvantages

• Higher effective cost if financing is provided by a third-party lender unfamiliar with the vendor or equipment.
• Used-equipment financing may be pricier because vendor incentives typically apply only to new products.
• Financing may exclude ancillary costs (transportation, installation, training).
• Vendor notes are often subordinated to senior debt; in bankruptcy they are paid after senior creditors.
• Default risk: vendor can repossess secured goods and may pursue other assets or future cash flows.

Example

A medical office needs a $1,000,000 surgical laser but has only $100,000 available. The vendor finances the remaining $900,000 under a five-year vendor note at 2% interest. The buyer receives the equipment and repays the vendor over time; the vendor records the loan and interest and may gain future business.

What happens on default?

Consequences depend on the agreement:
* Repossession of the financed equipment or inventory.
* Pursuit of other pledged assets or business cash flow.
* Enforcement actions per the vendor loan agreement, which may include acceleration of debt and additional penalties.

Subordination and priority

Vendor notes are commonly treated as subordinated debt, meaning they rank below senior lenders in repayment priority during insolvency or liquidation.

Vendor loan agreement

This document specifies the parties, amount financed, maturity, interest rate or cost terms, security interests, covenants, remedies on default, and any other conditions governing the vendor financing arrangement.

Bottom line

Vendor notes can be a practical financing tool for businesses that need inventory or equipment but lack bank credit or sufficient cash. They ease acquisition and can strengthen vendor–buyer relationships, but typically carry higher risk and potentially higher cost than senior commercial loans. Evaluate the full terms, security, and alternatives before committing.