Vendor Finance – what is this?

Posted by bowraven on 23 October, 2008 under Business advice, Business owner looking for investment, I am an investor, Looking to buy a business, Selling a business | 2 Comments to Read

Vendor finance is where someone selling a business is happy to effectively lend the purchaser money to buy it.

If you have not heard of this before, then you may well be thinking, why would I lend someone money to buy my business? This is a good question and is worth explaining.

Let’s say for example you are selling a business for £180,000 and you have a purchaser that is willing to pay you this £180,000. However, it might just be, and especially with the present credit crunch situation, that the buyer is unable to raise the finance through the banks. This could be for a number of reasons, one of which is that there is no security for the loan, either on the business itself or the purchaser has nothing to secure it against. In most cases, people tend to use their house as collateral to raise money, however, with recent events loans are harder to come by and house prices have fallen. Therefore, a loan that might have been easier to get say 12 months ago, might not be available or the amount available might be less.

In the case where you, as a seller of a business, are lucky enough to have found a purchaser would be silly to turn someone away simply because they are not able to raise all the funds by normal means. You could therefore, for example, ask for say £60,000 up-front with two further instalments due in 12 and 24 months time. Of course you could have any other combination of payment options and could even ask for it on a monthly basis.

You could also go for charging interest on the loan and I would urge you to take some form of security for the payment of the money lent, which might include their home and/or the business itself. So if in the event the purchaser does not pay you will get something back for your troubles. Getting the business back might not be what you had hoped for, but the purchaser, in this example, will have already paid you £60,000 up-front so if you can on-sell the business again, you will have cleared an extra profit at the expense of the “failed purchase”.

Benefits of “Vendor Finance”

One quite obvious benefit is simply you will be able to sell your business sooner rather than later, rather than leaving it until you find someone with the cash or with the necessary security to get bank finance.

The other not so obvious benefit is that you will be showing your would-be purchasers a level of confidence in your business, over and above someone who is not, if you are happy to accept finance secured on it. You may also find that this is an “Industry Norm” to take payment by instalments, for example the accounting industry it is normal to buy and sell accounting practices over 2-3 year period.

Disadvantages of providing “Vendor finance”

There are of course disadvantages of you letting someone pay over time, not least the person that buys your business may go out of business and you end up with no money, or just with the initial deposit paid at the outset.

The other disadvantage is that you will not receive all you money straight away, but if you charge interest, and you may well be able to charge a higher rate than you would normally get from the banks or building societies, you will earn something on your investment too.

The other disadvantage is that, should things go wrong then you may end up with the business back and it might be in a bad way, after having been run by the new purchaser for however long. There other thing is the business might go broke and, unless you have taken other security over the purchaser’s house or some other asset, you will have lost your money.

I would certainly advise you to make sure you do receive a substantial payment up-front of probably no less than a third of the selling price, thereby qualifying your purchaser. You don’t want to sell your business to someone and then a few months down the track, they have messed things up and you have no money up-front.

I would also advise you to do some form of credit referencing on the purchaser to make sure that the have no bad credit history, thereby making the whole transaction a higher risk.

Finally, if you are reading this article as a business purchaser, then I would suggest that you ask the seller whether they will accept “Vendor Finance”, as they might not have heard of this option and it could be the difference between you getting the business and not. It could also mean that you could buy a much larger business than you might have originally thought possible.

You might also want to take a look at Bowraven’s business purchase funding tool here.