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Vendor finance – worth considering?

By Frank Higginson01 Mar 2009

It appears to be the season for vendor finance in management rights transactions.

Normally vendor finance arrives in circumstances where the buyer’s cash equity contribution or stricter lending criteria mean that previously available funding arrangements are no longer there.

That could almost be the mantra for everything in this economic environment.

However, it is not all doom and gloom. Managed correctly, the provision of vendor finance can lead to a deal happening with both parties benefitting from it.

Like anything, vendor finance constitutes a risk that provides a return. It is always up to you as the seller to assess that risk. You are generally in a far better position than most lenders because you know the cash flow of the business inside and out, having operated it for any number of years, and this is what gives any buyer the ability to service any vendor finance loan.

The key elements to vendor finance from our perspective are:

  • How much is required? Normally, it will not be a large part of the purchase price – just the gap between the purchase price and the available cash equity and borrowing capacity.
  • When is it to be repaid, and more importantly what interest rate will be charged to it? In the environment of lowering cash rates, the return from vendor finance will be likely to be significantly higher than term deposit rates.
  • What security is being offered? Normally, the buyer will source normal debt funding from a bank. Any vendor finance will come in behind that in the priority. There will normally be a charge over the business, mortgage over the unit and a personal guarantee. Other property can also be offered.
  • Disclosure of the vendor finance to the bank providing primary debt funding is required. Failure to do that can lead to allegations that the bank has been misled, and this is not something that should be undertaken.

Don’t get this wrong – we are not advocating vendor finance as a first choice. Ultimately, cash is king and collecting all settlement proceeds is definitely the best option rather than vendor finance. For whatever reason, we are seeing more and more vendor finance questions, so if it is put to you, you now know a little bit more about it.

Finally, it is very important not sign a contract with vendor finance provisions until you have legal advice about it. There could be nothing worse than committing to vendor finance on uncommercial terms in a sale contract.