What is an intercreditor agreement when buying a business?

When a purchase is funded by more than one lender, an intercreditor agreement is one way for the lenders to settle in writing who is paid first if the business fails. One pairing is a bank and the seller, who holds a vendor take-back note for part of the price, but any creditors with a stake in the same business can sign one. It sits on top of the security each lender already holds.

Why rank matters before you sign

In Ontario, the Personal Property Security Act ranks security interests perfected by registration by the order of registration, if no other provision of the Act applies. Outside Ontario, ask a lawyer which province’s statute governs. An agreement can change the result between the parties: a secured party may subordinate its security interest to any other security interest, and the subordination is effective according to its terms (s.38). A creditor who agrees to subordinate therefore gives up, on the agreement’s terms, the priority that the order of registration would otherwise give it.

What a lender’s program may require

The Canada Small Business Financing Program guidelines show the kind of requirement a buyer may meet. When a CSBF term loan finances real property or equipment, the security must be a valid and enforceable first charge on the assets financed. Where an earlier charge flows from an after-acquired clause, the lender must obtain postponements of rank for the assets being financed. The guidelines also say that the amount a vendor finances is not eligible for a CSBF loan. Ask your lender which of its requirements affect the seller’s note. See how to finance a business acquisition in Canada.

What to read in the agreement

BDC notes that a financing structure may combine your own investment, a business loan and seller financing, so confirm each lender has seen the others’ terms. Ask what the agreement stops each creditor from doing: collecting payments, demanding repayment or enforcing security. Ask whether the seller may be paid while the bank loan is in good standing, how long any waiting period lasts, and what happens if the lenders disagree. Each answer can affect your own cash flow, so have a lawyer review it before you sign.