Vendor finance under a business or share sale can be attractive option to purchasers and help secure the sale, but can create signific risk and exposure for the Vendor. For that reason, Vendors should approach vendor finance as a credit decision, not just a commercial concession in a business negotiation.
If your business is being sold on Vendor finance terms, key considerations are:
- whether the proposed schedule of repayments is realistically achievable by the business;
- whether the debt is secured;
- how Personal Property Security Register (PPSR) registrations and guarantees are handled where any bank or other third-party lender ranks ahead of the vendor; and
- what the vendor can actually do if the purchaser defaults and what this means in practical terms
WHAT IS VENDOR finance in a business sale?
Vendor finance usually means the Purchaser pays part of the purchase price at completion, and the Vendor agrees to receive the balance over time, often by instalments and with interest. In substance, the Vendor becomes a creditor after the sale.
This can help bridge a funding gap and widen the Purchaser pool. However, it also means the Vendor remains financially exposed to a business they no longer own or control.
Secured versus unsecured vendor finance
The finance may be secured or unsecured. That distinction often determines how much protection the Vendor really has if the arrangement fails.
Secured vendor finance usually involves at minimum a personal guarantee from the directors of the purchasing entity, together with security over the purchasing entity and the business assets, or over other Purchaser assets such as a caveat over real estate. Where the amount under finance is significant, a mortgage over real estate should be seriously considered.
Unsecured vendor finance leaves the Vendor as a general creditor of the Purchaser, which carries materially higher risk and places the Vendor in a much weaker position if the Purchaser becomes insolvent.
In assessing whether to provide Vendor finance, the Vendor should assess the request in the same manner that a bank or third party lender would, including making an informed assessment of:
- the assets and liabilities of the Purchaser, (including requiring evidence of the same);
- the available equity in the purchaser’s assets, including requiring valuations to be provided;
- existing security holders, such as banks/mortgagees, including a review of what security will be taken by any additional lender on this transaction.
PERSONAL GUARANTEES: AN ADDITIONAL PROTECTION
Because Purchasers often purchase through a newly established company with limited assets, at a minimum the directors should be required to give personal guarantees for the finance. This gives the Vendor another avenue of recovery if the Purchaser company defaults.
Guarantees can be useful, but they are not a complete answer on their own. They still need to be carefully drafted, properly executed and, where appropriate, supported by additional security over the personal assets held.
PRIORITY ISSUES WITH BANK LENDERS
If the Purchaser is obtaining bank funding as part of the same transaction, the Vendor’s position must be considered alongside the bank’s security. Banks will usually require first-ranking security and will often control whether further security can be granted at all.
Even where a second security interest is permitted by the bank, the bank will commonly insist on a deed of priority or intercreditor arrangement. That can mean the Vendor is prevented from enforcing its security until the bank has been paid in full or has taken its own enforcement steps. In practicality, there may be little left to make payment to the Vendor after the bank has been repaid its debt and enforcement costs in full.
ENFORCEMENT OPTIONS IF THE PURCHASER DEFAULTS?
If the Purchaser defaults in the payment of the Vendor finance, the Vendor’s options depend largely on how the finance was structured. A secured Vendor may be able to enforce its security by appointing appoint a receiver, repossessing secured assets, or calling on personal guarantees, subject to any priority arrangements.
Retaking possession of the business, which invariably will have suffered loss and damage if the Purchaser has defaulted on the finance repayments, is rarely an attractive option to a Vendor who had hoped to have exited the business and in many cases be enjoying their retirement.
Retaking possession of assets and stock may be a more appealing option, if there is real value that can be recovered, but still requires a significant amount of work to be performed by the Vendor.
An unsecured Vendor has fewer options. They may still pursue debt recovery or formal insolvency steps, but recovery will depend heavily on the Purchaser’s solvency and what other creditors are ahead of them.
Enforcing any security will further result in a significant time commitment, stress, and not insignificant cost to the Vendor, which generally must be funded by the Vendor and added to the amount sought to be recovered.
WHAT SHOULD VENDORS CONSIDER BEFORE AGREEING TO VENDOR finance?
Vendors should treat Vendor finance as a risk-managed lending arrangement. Practical steps include:
- conducting a thorough assessment of the Purchaser’s financial position and ability to repay the finance;
- deciding whether vendor finance will be secured, and over which assets.
- ensuring PPSR registrations and related security documents are properly documented and registered.
- obtaining personal guarantees;
- understanding how any bank lender affects priority and enforcement;
- assessing, before signing, what recovery options would exist if default occurred, and the practical implications of seeking enforcement;
- considering whether the Vendor will have any ongoing role post-settlement in the management of the business for the duration of the vendor finance term.
The more the Vendor’s protection depends on assumptions rather than documents, registration and priority analysis, the greater the risk.
CONSIDERING SELLING YOUR BUSINESS?
Vendor finance can be a solid outcome for a vendor, widening the purchaser pool and ultimately getting a deal over the line.
But before you consider vendor finance options, you need to cover yourself for the possibility that you are left with a purchaser who defaults on their obligations, leaving you to chase them for payment.
If you are looking to sell your business on Vendor Finance terms, get in touch with one of our experienced commercial lawyers to consider your options and ensure your interests are protected through tools such as personal guarantees, PPSR registrations and priority arrangements.
