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Vendor Finance in Business Transactions

Sellers (vendors) and purchasers of a business sometimes enter into a transaction which involves Vendor Finance. The vendor provides some of the funding required by the purchaser to buy the business – usually the purchaser pays a deposit or portion of the purchase price and the vendor funds the balance (essentially by way of a loan from the vendor to the purchaser).

From a commercial and practical perspective, these arrangements can be beneficial to both vendor and purchaser in that:

• The purchaser has an opportunity to acquire a business which may not otherwise have been possible due to unavailability of finance. Generally, the purchaser pays a ‘premium’ for the opportunity to secure finance by paying a higher interest rate than that offered in the present market.

• The vendor secures a sale that may have been difficult to achieve in the present market or for the asking price. A higher rate of return than what might ordinarily be charged is factored into the agreement to account for the added risk and as a compromise for not receiving the full purchase price up-front.

If you are considering Vendor Finance for the sale or purchase of a business, there are important issues to consider. Your lawyer can explain the proposed transaction to you and work through solutions to reduce some of the risk involved.

General considerations for Vendor Finance

Vendor finance is essentially a legal transaction and like all such arrangements carries risk for both parties. It is important that the terms of the agreement are embodied in a legally enforceable document that clearly sets out the obligations and rights of both parties and provides for contingencies should things go wrong.

Business owners take a not insignificant risk in financing the sale of a business. However this may be the most feasible way to sell the assets and goodwill at the desired price and at the desired time.

Vendors can mitigate the risk by consulting with a lawyer who will draft the appropriate business and loan agreement and arrange for securing the loan.

Insisting that the purchaser provides a reasonable deposit may help secure the new owner’s commitment to the business generally and his or her obligations to repay the loan. If the purchaser has little to lose under the arrangement, then there may be less incentive to perform and repay the loan.

Before entering into a transaction involving Vendor Finance, business owners should request access to a purchaser’s financial statements and documents to assess the purchaser’s financial history and capacity.

What should be included in the agreement?

The following are some typical matters to address when preparing an agreement for Vendor Finance.

Who are the parties to the agreement? The agreement needs to accurately describe the parties whether individuals, a partnership, company or trust. Your lawyer will conduct appropriate searches to verify identities and to confirm that there are no bankruptcy or insolvency proceedings on foot.

If the purchaser is a company, then the agreement should provide for personal guarantees from its directors. Purchasers must be fully aware of their personal obligations under such guarantees.

What is being financed? The financing agreement needs to work in with the overall negotiations for the business and assets being acquired. There may be two agreements – one for the sale and purchase of business and one for the loan. These will be interdependent, meaning each agreement will rely on and be supported by the other.

How will the loan be protected? The loan should be appropriately secured by way of a mortgage, charge or registered security interest on the Personal Property Securities Register. A registered security interest over company assets enables the finance provider to appoint a receiver in the event of a default, however the vendor needs to be sure that there is sufficient value in the assets charged.

The vendor may also consider requesting a mortgage over other property owned by the purchaser or that the purchaser enter a deed of priority which will put the vendor ahead of other third party lenders.

What are the terms of repayment? The agreement must set out the term of the loan, frequency and amount of repayments, the interest rate and how this is calculated, penalty interest and what happens on default, and whether the loan can be paid out early. For business transactions repayment and interest terms should be on a commercial basis.

Conclusion

Vendor Finance offers an alternative means to secure the sale and purchase of a business. As each arrangement is unique, so too should be the agreement documenting the parties’ intentions. Too often people enter into agreements and are not fully aware of their impact, their rights and obligations. Furthermore, agreements are sometimes prepared that do not accurately reflect the parties’ negotiations.

After recognising potential pitfalls and implementing strategies to avoid these, an informed decision can be made to determine if Vendor Finance is suitable for your sale or purchase of business. Documents can then be drafted to suit your particular needs.

Your lawyer will look at the full scope of negotiations to ensure that a Vendor Finance arrangement is workable having regard to the parties’ intentions and the business and assets being purchased.

If you or someone you know wants more information or needs help or advice, please contact us on 08 9422 8111 or email buslaw@taitlegal.com.au.