Vendor Finance is Not a Dirty Word
Vendor Finance is Not a Dirty Word
Vendor finance, also known as seller financing or owner financing, can be a very effective way to sell a business in the current climate. It does however come with risks, so the team at SOT Business Brokers Perth explore some of the benefits and drawbacks.
What is vendor finance?
Vendor finance is when the seller of a business funds part of the business sale instead of the buyer going down the route of traditional lending. Typically the buyer will pay part of the price upfront and the finance terms are arranged via contract privately rather than through the banks. The buyer pays off the purchase price of the business (including interest) via instalments to the seller (vendor).
A worked example:
John wants to sell his café for $280-$300k. A very interested buyer has assessed their lending options and the maximum they can offer is $220k for the business. They simply can not get any more funds from any lender. This is much lower than John wants to accept. John offers vendor financing for a purchase price of $290k. The buyer pays John a $110k deposit and the remaining $180k is paid off in instalments over the next 24 months, at an interest rate of 6%.
Why can’t the buyer use traditional lending?
It’s no secret that the current lending landscape has become more difficult. In fact, it’s harder to get a loan in Australia now than it has been in years, possibly ever. Why? In recent years, the big banks have been hit by both the financial services royal commission and the media for lax lending standards. As such, changes have been implemented by the Australian Government to ensure the financial system remains strong. Great in theory, however the reality is that lending is much more difficult for your typical business buyer. This is especially true if the business for sale has no/limited tangible assets such as machinery or vehicles.
For buyers who are older and have assets/capital to leverage, it can be easier, however younger buyers without significant wealth creation are really suffering. Business brokers in Perth are seeing some deals fall through at the financing stage and for those who can get lending, the process often takes longer than previously. Lenders ask more questions, insist on more documents and have more hoops to jump through than ever.
Why take on the risk of vendor finance?
Vendor finance is used more often than you might think to achieve a better deal for both parties. Buyers see it as a way to reduce risk and it enables them to buy a business they might not otherwise have been able to finance. Sellers use it to access a wider pool of buyers and to achieve a faster sale at a higher price than they may have been otherwise offered. In today’s complicated lending landscape, buyers who can get loans are frequently getting less than they ask for and this shapes their offer to buy a business. The seller can of course accept a lower than anticipated offer, however,
vendor financing can allow a higher purchase price to be agreed. Vendor finance can not only prevent a deal from falling over, but the vendor also earns interest on the loan.|
What risks are involved with vendor financing?
If the buyer defaults on its agreed repayments, there is financial risk to the seller providing vendor finance. There are a number of effective methods for minimising the risk, including:
- Performing a credit check on the buyer to understand if they have defaulted in the past;
- Ensuring the loan agreement is properly drafted by an experienced commercial
- Lawyer;
- Agreeing securities and how they will be provided;
- Entering into a deed of priority, which would give the seller priority against third party lenders so they get “paid first” in terms of debt repayment;
- Limit the buyer’s ability to share the business’ profits until the seller has received full repayment under the repayment schedule of the agreement; and
- Grant power of attorney to the seller in the event of a default to regain control over any licences and assets of the business.
Vendor financing is generally not recommended if the business has a history of low profits and poor cash flow.
If you have any questions about vendor financing, please get in touch with SOT Business Brokers Perth today.
Tags: business owner small business tips buying selling
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