5 things you need to know about ‘vendor finance’

5 things you need to know about ‘vendor finance’

Whether you’re buying or selling a business, the chances are that ‘vendor funding’ will play an important role in getting the deal done.

For sellers, offering vendor finance can increase the pool of potential buyers, and therefore increase the sale price due to competitive tension. For buyers, vendor finance can provide an additional funding source that leaves traditional funding (such as from banks) for things like working and expansion capital.

Set out below are 5 things you need to consider from a seller’s perspective:

1. You should require a significant initial payment

As the seller you should require the buyer to make a significant initial payment towards the purchase price on settlement. Otherwise you are effectively giving the buyer an ‘option’ to purchase your business.

If the buyer is not able to make a significant initial payment, then they probably don’t have sufficient equity to be buying and running your business in the first place.

We generally see buyers require between 30% and 50% of the purchase price paid on settlement. Often some of this is borrowed by the buyer from a bank.

If the initial payment is still below these thresholds, then you should definitely have the buyer provide some level of personal guarantee for the balance, and you should take security over the business, so you can step-back in if the buyer defaults on the future payments. (See more about this below)

2. The buyer needs to have a good credit rating

If the buyer has a history of defaults with banks and other credit providers, chances are they will also default on you – in fact the chances are significantly higher because the buyer is likely to see you as ‘soft credit’.

It is very easy to run a comprehensive credit check on a buyer (with their permission), and this should be part of your ‘seller due diligence’ on the buyer – without exception. You may also wish to ask the buyer for at least 3 personal credit references that you can speak with directly.

3. You should charge interest

You should always charge interest on vendor funding – and at a rate that properly reflects the risk that you are taking in providing the funding to the buyer. If you do not charge interest then the buyer has no incentive to pay you off before other sources of funding.

You should also specify ‘normal’ and ‘default’ rates of interest, so you receive a higher return if the buyer falls into default. This needs to be carefully drafted to avoid being seen as an unenforceable penalty.

4. The buyer needs to provide security for the amount outstanding

If you do not take security for your vendor funding then you will rank in line with all the other creditors to both the business and the buyer personally – and your chances of getting anything back are negligible.

At the very least you should take comprehensive security over the business assets that you are selling to the buyer. This will give you the ability to ‘step back into the business’ if the buyer defaults. Given that you have been running the business prior to the sale, you are probably the best person to set things right if the buyer loses control. Your security may need to rank behind security given to the buyer’s bank – as a bank will generally not agree to provide funding on a second-ranking basis.

5. You will need to proactively manage getting paid

All too often we see sellers hang back and wait as a buyer falls into default. When they do take action, it is often too late to preserve any meaningful value. Just like a bank, you need to proactively manage getting repaid, and take immediate action to focus the buyer on repayment if they get behind.

To learn more about how you can successfully use vendor finance as a tool in selling or buying a business, call Andrew on 1300 654 590.

 


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Published by

Andrew

Lawyer to entrepreneurs and investors