When looking to sell your franchise, it can be very difficult to find the right buyer. If you are struggling to find someone to purchase your franchise, you may have received an offer for vendor financing. Vendor financing occurs where you accept part of the payment for the franchise upfront. Then, the purchaser pays the rest over time after the sale goes through. Vendor financing is problematic and can expose you to certain risks. This article explains when vendor financing may be appropriate and the preventative measures you should take if you take this option.

When is Vendor Financing Appropriate?

Vendor financing can be a complex process, and you should only consider it as a last resort. If you can find a buyer who will pay the full amount upfront, even if the price is slightly less than another offer involving vendor financing, you should go with the full payment upfront.  

Vendor financing adds to the complexity of documentation necessary to complete the sale. It is very expensive to engage in debt recovery action if the purchaser does not fully pay you after purchasing the business.

Buyers sometimes have what is known as “buyer’s remorse” and may become disappointed by various aspects of the business once they have begun operating it. Even if you are not responsible for their problems, they may still blame you and be reluctant to pay the rest they owe you. Buyers may even threaten legal action to delay paying the remainder of the purchase price.

Therefore, you should only consider vendor financing as a last resort if no other prospective buyers are available. Additionally, you need to be confident that your business is operating profitably, and the purchaser will be able to sustain the operation. This is important because you are effectively “lending money” to the business. As such, the business will need to be profitable for the buyer to be able to pay you in full.

It may, therefore, be preferable to simply wait to find a suitable buyer instead of participating in vendor financing.

Vendor Financing Tips

If you still wish to go ahead with vendor financing, there are a number of tips you could implement to ensure your business will be paid in full eventually.

Percentage of Purchase Price

You should ensure that the purchaser pays a substantial portion of the purchase price. If possible, they should pay at least 50% of the purchase price. If the purchaser does not have enough funds to purchase this percentage of the franchise initially, it could be even more difficult to recover the funds from them down the line.

Fees and Incentives

You should also ensure you do not charge exorbitant interest payments or other unreasonable fees. These fees will not compensate you for the risks of the purchaser not paying the money back. If the purchaser is willing to offer very generous interest payments or other incentives, this may be a sign that they are not necessarily considering their long term ability to pay back the loan.

In general, it will be better to have a lower purchase price and a higher upfront payment than a very high purchase price and a smaller upfront payment.

Purchasing Shares

Finally, vendor financing may be a more viable option if the purchaser buys shares in the business, rather than buying the business through a business sale agreement. When buying the shares, there are some flexible features that make vendor financing easier to implement. While vendor financing is never the best option, this process can make it easier to recover your assets if the other party fails to make payments.

The first advantage of this is that you can adjust the share transfers over time. 

For example, you could sell 50% of the shares initially, with additional transfers occurring when the other party makes further payments.

Further, if payment does not take place on time, it is relatively easy to force a transfer of shares back to you. Here, you can hold the shares as security for the loan. 

However, the purchaser may be reluctant to enter into this arrangement. This is because when they purchase shares in a company, they are taking up any past issues within the business. As such, they will need to be reassured there are no key issues that they will have responsibility for when the sale goes through.

Potential Issues With Vendor Financing

As stated above, the biggest issue with vendor financing is the risk of the other party not paying you in full. If payment is late and you attempt to recover this debt, the business may no longer be profitable. You will then need to make an assessment of the security you obtained when you agreed to vendor finance to see what options are available to recover the debt. Generally, you will have obtained one or more of the following as security:

  1. a personal guarantee from the purchaser’s director(s);
  2. shares in the purchasing entity company;
  3. a mortgage over a property the purchaser owns;
  4. a general security agreement securing the assets of the business; or
  5. inter-company guarantees from a holding company or related entity.

Enforcing any of these forms of security is expensive and time-consuming. You can only enforce many of these guarantees through court proceedings, including

  • personal guarantees;
  • mortgages; and 
  • general security agreements.

This could involve considerable legal costs.

Security Options

As stated above, to secure the remainder of the purchase price, you should obtain good security. This security can take several forms.

1. Business Sale Agreement

One option is to sell the shares in the business and have a mechanism in the business sale agreement, which automatically transfers the shares back to you if the other party does not meet their payments.

2. Personal Guarantee

Another option is a personal guarantee from an individual who has sufficient assets in their name to secure the rest of the payment. You could also choose to guarantee performance from another company that has significant assets.

For example, this could be a holding company or another family company. 

However, as assets can be transferred quickly and money can be difficult to trace, this option may be problematic to enforce.

3. Mortgage

Another option for taking security is a mortgage over land that the purchaser owns. This is generally the preferred form of security but is very rare as the property is likely already mortgaged to a bank. Further, if the purchaser has significant equity in the property, they should be able to access that equity and draw down on existing financing to pay for the business without the need for you to enforce this security.

However, if the property is available for a mortgage, this can be a very useful form of security.

4. General Security Agreement

A further option for taking security is a general security agreement over the assets of the business. This would allow you to gain access to and sell those assets if the other party does not make their payments on time.

However, you should be aware that this would not necessarily allow you to operate the business. It would merely allow you to sell the physical assets of the business. Securing the remainder of your payment through a general security agreement is a complex process as there may be competing security interests. It is therefore important that you confirm what other security interests the purchaser has before opting for this form of security

Key Takeaways

Vendor financing is a complex process and is fraught with many difficulties. While you should avoid undertaking vendor financing, if you have no other option, you must ensure that you take measures to ensure you will receive payment in full. These include:

  • restructuring the terms of the purchase; and
  • ensuring you have adequate security.

If you have any questions about selling a franchise, contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

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