What vendor finance is
Vendor finance is an arrangement where part of the purchase price for a business is paid after completion rather than on the day. The seller effectively lends the buyer the balance of the price, and the buyer repays it over an agreed period, usually with interest.
A typical structure sees 70% to 80% of the price paid at completion, with the balance paid in instalments over one to three years. The terms are usually set out in the sale agreement itself or in a separate loan agreement signed at completion.
Vendor finance can be the difference between a deal happening and not happening. It also changes the relationship between the parties: after completion the seller is a lender and the buyer is a borrower, and the sale documents need to deal with that.
Why parties use it
Vendor finance tends to appear in a deal for one of three reasons.
It bridges a valuation gap. If the buyer cannot fund the seller's number at completion, deferring the balance lets the seller hold its price and the buyer proceed without a larger upfront amount.
It widens the pool of buyers. Many capable buyers, including existing managers and employees, do not have the capital to pay in full at completion. Deferred terms let the business pass to the person best placed to run it, which benefits the staff and customers as well as both parties.
It aligns the parties after completion. A seller being paid from the business's future cash flow has a continuing interest in its success. That can support a higher price for the seller and a smoother handover for the buyer.
The risk for each side
For the seller, the risk is credit risk. Once the buyer has control, the seller no longer controls the cash flow that funds the repayments. If the buyer mismanages the business or stops paying, the seller's remedy is to sue on the debt or enforce whatever security it holds. Neither is quick or cheap.
Ranking makes this sharper. Where the buyer has borrowed from a bank to fund the completion payment, the bank will almost always take first-ranking security over the business and its assets, and will require the seller to sign a deed of priority or subordination deed confirming that the seller's debt sits behind the bank's. On an insolvency, the bank is paid first and the seller takes what is left.
For the buyer, the risk is the reverse. Security granted to the seller, restrictions on how the business is run, and acceleration of the whole debt on a missed instalment can constrain the buyer at exactly the point it is trying to integrate and grow the business. The buyer also needs any other lender it has to accept the seller's position, which may delay or complicate the facility.
Terms that are usually negotiated
The commercial terms are for the parties, but these are the ones that decide how the arrangement works in practice.
Amount and term. Sellers generally push for a smaller deferred portion and a shorter repayment period; buyers for the reverse. The longer the money is out, the more of the risk sits with the seller.
Security. Sellers commonly ask for a registered security interest on the Personal Property Securities Register, personal guarantees from the buyer's directors, and sometimes a mortgage over real property. Where a bank takes first ranking, the seller may take second-ranking security, and a priority deed can cap the bank debt that ranks ahead.
Interest and default interest. The interest rate reflects the risk the seller carries, and a higher default rate gives the buyer a reason to pay on time. Buyers will look to keep both at commercial levels.
Repayment and acceleration. Fixed instalment dates, with the whole balance becoming payable if an instalment is missed, is the usual seller position. Buyers often seek a grace period or a right to cure before acceleration applies.
Restrictions on the buyer. Until the debt is repaid, a seller may require that the buyer not sell the business, pay dividends, take on further debt or grant security to anyone else without the seller's consent. Buyers will seek to narrow these covenants so they can run the business normally.
Set-off. Buyers will usually want the right to withhold deferred payments against warranty claims raised after completion. Sellers will resist this, or confine it to claims that have been agreed or determined, subject to a cap. How set-off is resolved often matters more than the interest rate.
Getting the documents right
Both parties benefit from agreeing the vendor finance terms in an initial heads of agreement rather than leaving them for the sale contract. Security, ranking and covenants are much harder to negotiate once the parties are months into a deal and committed to completing.
Sellers should do their own due diligence on the buyer: who is behind the buying entity, what assets the guarantors actually hold, how the completion payment is funded and what the bank's facility says about the seller's debt. It should not be assumed that any senior lender of the buyer will accept a seller's security. A bank that objects to the seller's ranking or covenants late in the deal can force the whole structure to be renegotiated, so the lender's position should be confirmed before the terms are agreed.
How we can help
Rouse Lawyers acts for buyers and sellers of private businesses across Australia. We negotiate and document vendor finance arrangements, including security, guarantees and priority arrangements with financiers. If vendor finance is on the table in your transaction, talk to us before the structure is agreed.
Disclaimer
The information contained on this website is for general guidance on matters of interest only. The application and impact of laws can vary widely based on the specific facts involved.
Accordingly, the information on this site is provided with the understanding that the authors and publishers are not providing legal advice. As such, it should not be used as a substitute for consultation with professional legal advisers. Before making any decision or taking any action, you should consult with a professional lawyer from Rouse Lawyers.
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