In Short
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Vendor finance lets the seller fund part of the price; the buyer pays a deposit at settlement and the balance in instalments with interest.
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The seller carries more risk—reduce it with a larger upfront payment, registered security (PPSR) and personal guarantees.
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Document clear terms: interest rate, repayment schedule and term, default rights, security, guarantees and priority with other lenders.
Tips for Businesses
Do due diligence on the buyer’s finances. Cap the loan to what you can afford to risk. Register security promptly on the PPSR and obtain a priority deed. Require director guarantees. Include tight default triggers and enforcement rights, and seek specialist legal and tax advice before agreeing terms.
Vendor finance occurs when the person selling a business also funds part of the purchase price. The buyer pays the seller an initial amount upfront on settlement, with the balance of the purchase price (including interest) over an agreed period of time, usually in agreed instalments. Vendor finance presents various risks and opportunities for the parties. This article explains where vendor finance may be appropriate, the associated risks and the key considerations involved in entering into vendor finance arrangements.
When Should You Use Vendor Finance?
Vendor finance may be appropriate when, for example, the purchaser is unable to obtain finance to purchase the business via a traditional lending institution, such as a bank. While these arrangements are not always the most desirable option for the selling party, sometimes this type of funding allows the vendor to get the price it is looking for. The seller also receives the benefit of interest, which generally accrues on the balance of the purchase price.
Risks Related to the Vendor & Ways to Reduce These Risks
If the buyer defaults on its repayments, there is an obvious financial risk to the seller as the buyer may be unable to repay you.
As a seller, there are practical ways to minimise unwanted risk in vendor financing arrangements, some of which include:
1. Negotiating the Highest Possible Upfront Payment
The less money owed to you by the buyer, the lower the risk of default.
2. Registering a Security Interest Over the Buyer’s Assets
Vendor financing agreements often contain provisions requiring the purchaser to grant the vendor a security interest over the business’s property. This essentially means that if the buyer defaults on repaying the outstanding loan amounts, the vendor can seize control of the buyer’s assets to recoup its costs.
To ensure you have a ‘perfected’ interest, you should register any security interest with the appropriate government register.
3. Engaging a Legal Professional to Advise on Appropriate Vendor Financing Terms, Including Repayment and Interest Obligations
It is important to strike a balance between a fair and reasonable arrangement and one that benefits the seller, given the seller is assuming the bulk of the risk.
A lawyer specialising in this area can provide tailored, thoughtful solutions for your specific needs.
4. Requiring the Buyer to Provide a Personal Guarantee
If the buyer is a company, the director(s) of that company are often required to provide a personal guarantee. This means that if the buyer entity defaults on the loan, the seller can seek to recoup its costs from the directors of the buyer entity personally.
If the buyer is an individual, it may be required to provide a third-party guarantor.
Continue reading this article below the formCommon Terms in Vendor Finance Loan Agreements
Vendor financing documents typically include the following key terms, among others:
the amount being borrowed;
the rate and manner in which interest will accrue on the balance of the loan (typically between 7%-15% annually);
the repayment schedule (e.g. every month, quarterly, on specific dates);
the term of the loan (e.g. 1-2 years);
whether the buyer is required to provide a guarantor and the obligations of that guarantor if the buyer defaults;
the seller’s rights in the event the buyer defaults; and
whether the buyer is required to grant a security interest over its assets in favour of the seller.
The parties usually incorporate these terms into the contract of sale in respect of the business, or otherwise draft them into a separate vendor finance loan agreement.
Protecting the Seller through Security
The seller must require the buyer to provide “security” in the event the buyer fails to meet its repayment obligations under the loan. This ensures optimal protection. Common security interests include:
“general security interest” in respect of all of the buyer’s present and future assets;
“specific security interest” in respect of one or more specific assets held by the buyer; and
mortgage over property owned by the buyer.
The value of the assets in respect of which security is granted should be sufficient to ensure that if the seller needs to call on the security interest, it will be able to recoup all or substantially all of the money owed under the loan.
If your vendor financing agreement requires the buyer to grant a registrable security interest over the business’s assets, you can register that interest on the Personal Property Security Register (PPSR). By registering your security interest, you become a “secured creditor”, meaning that if the business becomes insolvent, you will have priority ranking over any “unsecured creditors” who may be owed money by the buyer. As a secured creditor, you will also rank ahead of the buyer’s shareholders in the event the company goes under.
Buyer Obligations
Under the vendor finance loan agreement and in addition to the obligation to repay the loan, the buyer may also be required to:
- enter into a deed of priority. This document gives the seller priority against other third party creditors who may also be owed money by the buyer;
- have a certified accountant prepare a statement of assets and liabilities and a cash flow statement. These financial reports aim to assure the seller that the buyer does hold the assets;
- limit the extent to which the buyer can share in or distribute the profits of the business until the seller has been repaid in full. This ensures the seller is repaid before the buyer or shareholders; and
- grant power of attorney to the vendor in the event of a buyer default. This will allow the seller to do all things required in order to make good on the buyer’s promises and obligations under the agreement.
When you are ready to sell your business and begin the next chapter, it is important to understand the moving parts that will impact a successful sale.
This How to Sell Your Business Guide covers all the essential topics you need to know about selling your business.
Key Takeaways
Vendor financing arrangements can be very beneficial as the seller receives the benefit of interest on the loan amount, but these arrangements are also risky.
As the seller, there are strategies you can implement to mitigate your risk, such as:
lending an amount, and on terms which you are comfortable with; and
carefully considering the buyer’s financial position and their ability to repay the loan.
Each vendor finance arrangement will have its own unique risks. You should weigh these risks against the potential benefits and seek legal and financial advice.
To discuss the ins and outs of vendor financing arrangements further, our experienced sale of business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Vendor finance is where the person selling a business loans the buyer part of the purchase price. The buyer pays an initial amount and then pays off the remaining balance with interest.
You should use vendor finance when the person buying the business cannot get a bank to finance the purchase. It may also help the seller to get the price they are looking for.
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