Vendor Finance - Bridging the Funding Gap

Vendor finance is a way of facilitating the purchase of a business by a vendor agreeing to receive a portion of the purchase price after the date of settlement. The portion of the purchase price that is not paid on settlement is paid off over a period of time on agreed terms and conditions.

Vendor finance is often used to bridge the gap between the finance a purchaser can secure through a bank and the agreed purchase price. For this reason, vendor finance has grown in popularity over the last few years due to the present economic conditions and higher interest rates.

Vendor finance is typically structured in the form of a loan from the vendor. Vendor finance may also be considered to include an “Earn Out” provision. Each structure has its own advantages and disadvantages discussed briefly below.

By Loan

Vendor finance by loan is where the vendor loans some or all of the purchase price to the purchaser on agreed terms, to be paid to the vendor over an agreed period of time.

A loan from the vendor can be attractive to both the purchaser and vendor. Vendor finance can help have the parties agree on a purchase price which would not otherwise be achievable without the structure in place. The purchaser can acquire the business which the purchaser may not have been able to secure without the vendor finance. The vendor achieves the intended sale price and potentially charges interest rates that can be more than would be earned on a bank deposit.

If the bank is providing finance as part of the transaction, a purchaser would need to work with their finance broker carefully. The bank will consider the vendor finance as a liability which is to be included in their assessment of the purchaser. The bank’s terms can also impact on the intended terms between the parties, for example, banks will require first ranking security over the business assets.

Earn Out

An earn out structure provides that part of the purchase price is deferred until a future date and is made contingent on the performance targets that are carefully considered by the parties. These targets may be based on the financial performance of the business or other requirements such as retaining key customers or maintaining regulatory approvals.

Earn out structures work well when a purchaser is uncertain, and the vendor is confident, of the continued performance of the business. It helps encourage the purchaser to purchase the business as they mitigate their risk of overpaying while still ensuring that the vendor’s investment is protected.

Earn outs bring both vendor and purchaser together in the transaction.

Financing the purchase of a business needs to be done carefully to protect all those involved. Precise drafting and detailed knowledge of ways to structure the financing are required. Please contact us to discuss your options.

Want to know more? Tune in as Alistair and Chris dive into this topic in detail.