Vendor funding: calculated risk or cause for concern?
Vendor funding is a type of sale agreement that’s becoming increasingly common. In fact, some would say it’s becoming a growing problem and needs to be handled with care. But what exactly does it mean, when might it be used and how can business owners mitigate the risks involved?
What is Vendor Funding?
Vendor funding is when the buyer of a business does not want to pay the full sale price at completion. Instead, the vendor is asked to wait for their money. There are two types of payments:
1 Deferred payment
The buyer does not have or cannot raise the money to pay, so the vendor is asked to act like a bank. It may simply be that they want to spread the cost of payment for cashflow purposes. Whatever the reason, serious consideration should be made to security and interest for the loan you are providing as vendor. The deferred payments might be guaranteed and written into the contract of sale, but who pays them if the company goes into administration?
2 Earn out
These are offered due to risks in the business that have not been addressed before sale. This could be around a dominant customer, key staff member, undelivered potential or simply the risk associated with the owner leaving. The buyer may be concerned that the projected profits have too much risk attached and will pay the vendor when those profits are seen. Unfortunately, many earn outs fail to deliver due to the risk factors involved. If the new owner changes everything about your business (which you now have no control over) customers could walk away and profits plummet. In this scenario, any earn out promised could be worthless compared to the calculations projected at the time of sale.
Why use vendor funding?
Vendor funding is often used when the vendor needs a quick sale. Perhaps the company is in trouble, about to go into liquidation, or the owner’s personal circumstances are dictating the timescale. For a failing company, struggling to survive, the arrival of fresh business expertise may be exactly what’s needed, almost at any cost.
Is it advisable to steer clear?
Imagine you’re your business as a classic car. You’ve looked after it, nurtured it, watched it grow in value and loved it. If a buyer came along and offered you half what it’s worth to hand over the keys now and said after 3 years he would pay you how much he thought it was worth then, would you sell?
Vendor funding is not necessarily the most fair and equitable solution for both parties. The vendor is effectively lending the purchaser money. They’re handing over the keys to their company along with full control of the decision-making and upkeep.
If a buyer is attracted to your business, can see the benefit of owning it, and wants to run it, then they should expect to pay a fair and reasonable price when they take charge of it. In our opinion, buying and selling businesses should be a win-win situation for everyone involved.
It’s therefore essential to understand why the buyer wants to defer payment for your business and to carry out full due diligence on them before progressing the deal.
Three key questions to ask yourself;
- Do you trust them?
Follow your gut instinct. Do you trust the skills and intentions of the buyer? Have they got a proven track record in your industry? Are you happy to place your business in their hands? Would you hand over the keys of your vintage car to a learner driver?
- Are their concerns genuine?
Does the buyer have a legitimate reason for requesting the terms? What kind of security are they offering you to support the purchase? If the buyer can’t offer a personal guarantee then it might be time to step away from the sale.
- Are they are hiding anything from you?
Full due diligence checks will reveal if the buyer is a true match for your business. Credit scores, trading history, loan and mortgage payment upkeep can all give an indication of how they behave in business. Have they been struck off as a director of another company.
We are used to the phrase “buyer beware”, but when you are being asked to support a new business owner by leaving money behind in your business after you leave, then it becomes “vendor beware”. Please take the same precautions any bank or financial institution would take when granting a loan.
Engaging the support of a Business Broker can help you navigate the tricky and complicated world of vendor funding. Of course, the best way to ensure you receive full cash offers when you are ready to sell your business is to prepare your business for sale before you sell. Your business will become more valuable, you won’t be placing your hard work and wealth in someone else’s hands, and you’re more likely to achieve an agreement that’s fair and equitable to both parties. Get in touch if you’d like to talk.