Vendor finance refers to an arrangement where a person selling a business also funds part of the purchaser price. Under a vendor finance loan agreement, the buyer pays an initial amount upon settlement and then provides the balance over an agreed period of time with regular payments. Vendor finance can be useful for both buyers and sellers, but it is important to be aware of the risks and have a well-drafted business contract or loan agreement.
Why Use Vendor Finance?
Vendor finance is often used when the buyer is unable to get a bank to finance the purchase of the business. It provides an opportunity for the buyer to enter the market or acquire a business at short notice. This arrangement also allows the vendor to sell a business at a preferred price, earn interest on the loan while the buyer pays it off, and facilitate a quicker sale.
A Vendor Finance Loan Agreement
A vendor finance arrangement may be incorporated into a contract of sale or drafted into a separate loan agreement.
Key terms include:
- Parties to the agreement;
- How much is being borrowed;
- The interest rate of the agreement;
- The repayment schedule (e.g., every month);
- Term of the loan agreement;
- The form of the loans (e.g., is it an interest-only loan?);
- How financial reports will be provided;
- Securities and how they will be provided.
The vendor should ensure that security is included in the loan agreement to protect them if the buyer fails to meet repayment schedule deadlines and defaults. The most common forms of security include:
- A mortgage covering business assets;
- A mortgage over property owned by the buyer;
- A charge over the buyer’s assets.
Additional Protections for the Vendor
The vendor may require the buyer to take other steps, such as entering into a deed of priority which would give the seller priority over third party lenders. This ensures the vendor is ‘first in line’ for debt repayment. Additionally, the buyer could be required to limit their ability to share the business’ profits until the seller has received full repayment under the agreed repayment schedule. Furthermore, the buyer (and its directors) may be required to provide personal guarantees as to the repayments so that the vendor is not solely reliant on the buyer.
Risks for the Vendor
The vendor faces the financial risk of the buyer defaulting on repayments. However, this risk can be minimised by ensuring there is a properly drafted loan agreement, and that adequate security is provided by the buyer. It is also important that the vendor does not provide too much finance as this may reduce the buyer’s commitment to the business.
Risks for the Buyer
Vendor finance agreements can be complex and cause the buyer to pay a price much higher than the actual value of the business. Therefore, a buyer should seek legal advice on drafting the contract and minimising the risks involved.
Vendor finance provides a useful way to obtain finance and to purchase or sell a business. There are risks and opportunities for vendors and buyers with this type of arrangement. It is beneficial for vendors to seek legal advice on questions such as the financial risk, the likelihood of a default and the security that the buyer can offer. Given the complex nature of these agreements, buyers also want to ensure the terms are fair and that they understand their obligations.
For advice on a sale of business agreement, loan agreement or other business arrangements, contact our team of Commercial Lawyers on 1300 337 997 or by filling out the form on this page.