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Selling your business is no easy task. After all, prospective purchasers will not always offer you your asking price. However, vendor financing can provide you with the means to sell your business other than through an ordinary sale. Vendor financing is where the seller funds part of the purchase price via a loan. In this sense, the money the purchaser uses to buy the business is made up of their own money and the money the vendor loaned them. Consequently, the purchaser must repay the loan to the vendor in instalments. This article explains the risks associated with vendor financing and how you can protect yourself if you decide to undertake vendor financing.
What is Vendor Financing?
Vendor financing is where the vendor who sells the business also funds part of the purchase price via a loan. Consequently, the purchaser must:
- pay an initial amount upfront; and
- repay the loan to the vendor in instalments with interest.
Of course, finding a purchaser who can pay the entire purchase value upfront is preferable and less risky. On the other hand, vendor financing involves additional financial risk for the vendor. This is because the purchaser could default on their loan repayments and consequently increase the legal costs involved in the transaction. However, vendor financing can be useful if you struggle to find a purchaser at the right price.
A person providing vendor financing faces financial risk if the purchaser defaults on their repayments or the business becomes insolvent. Additionally, a purchaser may experience ‘purchaser’s remorse’. This is where their pre-purchase excitement does not align with the reality of the day-to-day running of the business. Although the purchaser has contractual obligations to pay you the outstanding amount, a vendor financing arrangement comes with a potential risk of the purchaser defaulting on the agreement.
However, there are ways to minimise such risk, as the table below explains.
|Negotiate reduced upfront finance||You should aim to receive at least 50% of the purchase price upfront. The higher the upfront payment, the less you have at stake in the event of default.|
|Register security interests||All vendor financing agreements should contain provisions that require the purchaser to grant the vendor a security interest over the business’ property. This means that if the purchaser defaults on repaying the outstanding amounts, the vendor can take control of the assets to cover their costs. To ensure you have a ‘perfected’ interest, you should register any security interest with the appropriate government register.|
|Reasonable interest terms||You do not want to burden your purchaser with excessive repayments or fees. You want to create a repayment situation that is fair and likely to succeed. For this reason, you should set interest rates on reasonable terms.|
|Directors’ guarantees||If the purchaser is a company, you can request that its directors provide personal guarantees. This means that if the company cannot repay the loan, its directors are personally liable for making the repayments.|
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Registering Your Security Interest
The vendor financing document will contain a clause requiring the purchaser to grant you a registrable security interest over the business’ assets. Once you register your security interest on the Personal Property Security Register (‘PPSR’), you will become a secured creditor. Consequently, you will have priority ranking over unsecured creditors and company shareholders in the event the business undergoes liquidation.
You can take specific steps to gain super priority on the PPSR. For example, if you obtain a mortgage over the business’ land or buildings, you must register this on the Torrens Title Register of your applicable state or territory.
Some common types of security you could require from the purchaser include a:
- mortgage over particular business assets;
- mortgage over property owned by the purchaser; or
- floating charge over the present and after-acquired assets of the business (a general security agreement).
Gaining a security interest can be complicated in situations where there are competing security interests. To ensure your interest will be adequate for the risk level, ensure you undertake the appropriate searches during the due diligence process.
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.
Vendor financing is where a vendor who is selling a business also funds part of the purchase price via a loan. Consequently, the money the purchaser uses to purchase the business will be a combination of their own money and money the vendor loaned them. The purchaser then has to repay the loan to the vendor in instalments. While vendor purchasing sounds enticing, you must take precautions to reduce the inherent risk of such a venture.
If you have questions about vendor financing, our experienced business sales lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Vendor financing is where a vendor who is selling a business also funds part of the purchase price via a loan.
Super priority takes priority over all other security interests in the same personal property, regardless of when you perfect the interest in the property. Perfecting your security interest can include registering it on the Personal Property Securities Register.
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