For business owners wishing to sell, an effective way to achieve a sale at the best possible price could be is for the vendor (seller) to finance part of the sale. Vendor finance is used more often than you might think to achieve a business sale and it can present tremendous opportunities for buyers and sellers to consummate a better deal for both parties. Purchasers see it as a way to reduce risk and get into a business they might not otherwise have been able to finance. Vendors use it to achieve a faster sale at a better price then may otherwise have been achieved.
WHAT IS VENDOR FINANCE?
In simple terms, it is money left in a transaction on pre-agreed terms and conditions by the business owner (vendor) so they can achieve the asking price for their business when there is a shortfall in a purchaser’s equity and bank finance. Vendor finance can take many forms, from an uncomplicated secured term loan to a structured ‘earn out’ arrangement that is based on the business achieving agreed levels of performance at a point in the future.
WHY USE VENDOR FINANCE?
The biggest advantage to the seller is making the business more affordable to a wider selection of buyers. By widening the potential number of buyers, the Vendor vastly increases their chance of achieving a sale more quickly and at a better price. Their business stands out from others on the market. From the purchaser’s point of view, it solves the difficulties of obtaining finance from a bank and the vendor’s confidence in offering finance makes the business appear less risky.
Example Secured Term Loan:
- Purchase price of a business is $1,000,000
- Purchaser pays $750,000 on settlement and a further $250,000 over two years at 7% interest only payable monthly with the loan secured on the assets of the business, a 2nd mortgage over the purchasers real estate and backed by a personal guarantee from the purchaser. After two years the purchaser refinances and pays the vendor out.
There are many variations of vendor finance. It’s a matter of coming up with an approach that suits both parties and agreeing the terms in writing.
TYPICAL VENDOR FINANCE TERMS
In a vendor finance loan, the following terms are typically put into the sale &purchase agreement or perhaps a separate loan agreement:
- The amount being borrowed;
- The interest rate to be charged
- The frequency of the payments (monthly?)
- The term (years) and form (interest only?) of the loan
- Securities and how they will be provided.
- Who pays the legal costs associated with the loan
In the event of an earn-out, performance milestones and how and when financial reports will be provided to the vendor will also be agreed.
MAKING IT SAFE
Obviously, there is a financial risk to the seller providing vendor finance. Happily, there are a number of effective methods for minimising the risk. This includes making sure that:
- The loan agreement is properly drafted by an experienced solicitor
- The loan is secured by a charge over the assets of the business being sold
- The loan is secured via a charge over the assets of the purchasers business and/or mortgage over real estate property owned by the purchaser.
- The purchaser providing personal guarantees
A vendor might also consider requiring the purchaser to do any of the following:
- Enter a deed of priority, which would give the vendors loan priority against third-party lenders.
- Limiting the purchaser’s ability to borrow more money until the seller has received full repayment.
- Require the purchaser to give the vendor a first right to buy the business back at a pre-agreed pricing formula should the purchaser default.
Vendor Finance can be a very creative method of financing to get the deal over the line. Any vendor finance arrangement will have risks. However, these risks should be weighed against the potential substantial benefits of a faster sale at a better price for the vendor and a lower risk, easier transaction for the purchaser. There are common sense mechanisms through which the vendor can protect their interests. Both parties must take sound legal and financial advice.
So when it is time to sell, or if your business has been on the market for a while without achieving the sale you want, make sure you consider the vendor finance option!
Bruce Cattell & Martin Plom
P: 05 555 6024 M: 021 779 439
P: 09 555 6048 M: 021 051 5507