Selling your business with vendor finance; a big no no

If the bank won’t lend the purchaser money, why should you?

In the inevitably challenging economic times we find ourselves in following the COVID-19 pandemic, it is increasingly likely we will see vendors desperate to sell their businesses and money conscious purchasers prepared to take on the business and make it a success. The solution parties often come up with seems to solve everyone's problem – the provision of vendor finance. What could possibly go wrong?

Vendor finance occurs when a seller agrees to fund some of the purchase price. Usually the purchaser will pay an initial amount at settlement, and then pays the remaining balance (plus interest) over an agreed period of time, with regular repayments. Vendor finance often occurs when the purchaser cannot obtain finance from the bank, or another lender, to purchase of the business. For a vendor it can sometimes lead to getting a better price for the business, however there are significant risks involved.

When a small business is sold on terms or with vendor finance, security must be considered. The usual forms of security are:

1. mortgages over real estate owned by the purchaser
2. registering a charge over the assets of the business and the purchaser's company
3. director guarantees (when the purchaser is a company, the director personally guarantees the repayments)

This is where the risk comes in. While the vendor may consider such securities to be satisfactory, that is not always the case. The commercial reality is that if you offer the purchaser a vendor loan, they will be unable to repay you.

Upon settlement the purchaser will be taking control of the business and its operations. In the event the purchaser is unable to adequately manage the business or its finances properly, there is the risk that the business will become insolvent. In a case of insolvency, there is no guarantee that all creditors will be paid the full amount of their debt, despite the vendor registering their interest. The ultimate risk the vendor will not be able to recover their money and the business is no longer solvent.

We often hear vendors say they will place a charge over the purchaser's home. Again, this may seem like a good idea, but experience tells us otherwise. Chances are, the purchaser will already have a mortgage to repay for their home, meaning the bank have the first registered interest. If the property has to be sold to repay debts, the bank is first in line with the vendor left to recover the leftovers, if any.

The bottom line is Vendor finance is rarely worth it.

Our business lawyers can help you with all aspects of selling or buying a business, including discussing the use of vendor finance. Contact Siobhan Liston on 03 5445 1067 or Lachlan Edwards on 0427 916 442.