In many cases, small businesses can be difficult to sell. Particularly in niche or unusual industries, finding a buyer who is able to fund the purchase, whether through finance or cash is key.
However, given the tight lending conditions of most banks when it comes to purchasing businesses, particularly where the buyer is unable or unwilling to provide real estate assets as security, it often falls to the seller to provide a loan to the buyer by way of deferral of part of the purchase price (known as ‘vendor finance’) – this is effectively a loan of part of the purchase price to the buyer.
In many cases, this allows the seller to get a better price for their business than would otherwise be the case, but does have some significant risks that should be considered.
Remember – the bank wouldn’t lend them the money so you need to approach with caution! So how does a seller protect themselves when providing vendor finance?
Just like any good finance provider, you should ensure that you obtain details of the buyer’s credit history, details of any credit defaults and a summary of the buyer’s assets and liabilities (preferably certified by its accountant).
What is typically offered is a registered security interest back over the business and/or other assets of the buyer. The theory here is that should the buyer default on their repayment of the loan, the seller can take steps to seize the business and resell it.
However, that is not all as simple as it sounds as appointing a receiver to seize assets covered by a security interest can involve cost and delay and negotiations with third parties such as landlords.
Don’t forget that there is likely to be a good reason that the buyer has been unable to make repayments. If the buyer has run the business poorly the business may be insufficient to cover the value of the vendor finance component.
Also, in many cases the buyer will have borrowed from another financier who will be first in line to receive any proceeds from the sale of the assets.
Where the buyer is a company or trust and has limited assets and liabilities, personal guarantees should be obtained from directors and/or shareholders.
If you are going to rely on a personal guarantee then it is important to ensure that you have assessed the guarantor’s credit history, details of any credit defaults and a certified summary of their assets and liabilities. There is little point in throwing good money after bad by chasing a guarantor who has limited assets.
Mortgage over real property
The best form of protection for any loan is obtaining a registered mortgage over real property of the buyer or their guarantors, particularly where you are the only mortgagee and there is sufficient value in the property to fully protect your interests.
This is like finding the holy grail…and just as rare.
Don’t forget that the buyer is effectively holding your money for a period of time and there will be a diminution of its buying power due to inflation and a risk inherent in any lending arrangement that you will not be repaid your principal sum. Accordingly, you should ensure that you are compensated by charging a reasonable commercial rate of interest on the loan.
We also strongly recommend that the vendor finance loan agreement provides for a rate of default interest to be charged and a requirement that the full amount of the loan, costs and interest become immediately payable upon default.
Where sellers do not include such terms, it becomes very tempting for a cash strapped buyer to put the seller at the end of the queue when it comes time to pay any creditors.
It is crucial to obtain legal advice from someone with relevant experience to analyse your potential risks and prepare documents that give you the best protection for the circumstances.
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