Vendor finance: how it works when the seller lends part of the price

With vendor finance, the seller agrees to receive part of the price after settlement, in instalments, instead of all of it on the day. Our guide to financing a business purchase introduces it alongside bank loans. This guide goes deeper: the terms, the seller's security and the risks for each side. It is general information, so get advice from a solicitor and an accountant before you agree to anything.

How vendor finance works

The buyer pays part of the price at settlement, from their own money, a bank loan or both, and the seller lends the rest. The buyer takes over the business and repays the seller over an agreed period, sometimes with interest and sometimes without. Instead of a clean break, the seller stays financially tied to the business until the last payment is made.

When it is used

• A gap between the loan and the price. The buyer's own money and what a bank will lend fall short of the price, and the seller funds the difference.
• An experienced buyer with limited capital. Someone who knows the industry may be a capable operator without a large deposit.
• A seller confident in the business. A seller who expects the profit to continue may be willing to be paid over time, and offering it shows a buyer that confidence.

A seller does not have to offer vendor finance. If you would need it, raise it through the listing's enquiry form, which goes straight to the seller or listing agent.

Working alongside a bank loan

Vendor finance often sits alongside a bank loan, so tell your lender about it early. Things to check include whether the lender will accept part of the price being deferred, whether it will count both sets of repayments when assessing the loan, and whether it wants its security to rank ahead of the seller's, with the seller agreeing to that in writing.

Ranking matters if the buyer defaults. Under the default rules described by the Personal Property Securities Register (PPSR), a registered interest generally ranks ahead of an unregistered one, and between registered interests the earliest generally ranks first, with some exceptions. A secured party can agree to let another registration rank ahead of theirs. Whether a bank requires this is for the seller's solicitor to work through with the lender.

The terms to document

A solicitor should put the arrangement in writing, covering:

• The amount. How much is deferred.
• Interest. Whether it is charged, the rate, whether it is fixed or variable and how it is calculated.
• The repayment schedule. How often payments are due, how much each one is, and whether there is a larger final payment.
• Early repayment. Whether the buyer can pay out the balance early, for example when refinancing, and at what cost.
• Missed payments. Any grace period, the notice the seller must give and the time the buyer has to catch up.
• Default and remedies. What counts as default, such as missed payments, insolvency or losing the lease, and what the seller can then do: demand the whole balance, enforce their security or claim under a guarantee.
• Personal guarantees. Where the buyer is a company or trust, the seller may ask directors or other individuals to guarantee the debt.
• Restrictions while money is owed. Limits on selling the business, changing who controls the buying entity, moving premises or borrowing more, and duties to keep insurance and the lease in place and to share financial information.

Security for the seller

Without security, a seller is likely to be an unsecured creditor, and the PPSR notes that if a customer becomes insolvent, secured creditors are generally paid first. Security for vendor finance can include a security interest over the business's assets, for example a general security agreement over a buying company's assets, and personal guarantees.

What the PPSR is for. The PPSR is a register of security interests in personal property, which covers almost everything that is not land, buildings or fixtures. It is not a register of ownership. Registering lets others know the interest exists and can give the secured party extra protection, including priority over other interests, especially if the grantor becomes insolvent.

Who registers. Generally the secured party, which here is the seller. There must be a real security interest behind it: the PPSR recommends a written agreement recording the interest, and warns that registering without one can breach the law.

Timing and details. The PPSR advises registering as soon as possible, because protection starts from registration. Its timing rules set a limit for registering against a company: within 20 working days after it signs the security agreement, or more than six months before insolvency begins. The buyer must also be identified correctly, usually by ACN for a company, and the PPSR warns that wrong grantor details can make a registration ineffective.

Because a mistake can leave the seller unsecured, have a solicitor prepare the security documents and handle the registration. Security over land, such as the buyer's home, is dealt with separately, as land cannot be registered on the PPSR. Once the debt is repaid, the PPSR's timing rules set short limits for ending the registration.

The risks for each side

For the seller:

• The buyer runs the business down. The assets securing the debt may be worth less, and the business may not earn enough to pay you.
• The buyer stops paying. Enforcing the agreement takes time and legal costs, and a bank that ranks ahead of you is paid first. The PPSR recommends legal advice before any enforcement action.
• Getting back a different business. If you take back the business, it may have lost staff, customers or the lease.

Check the buyer as carefully as they check your business: their experience, finances and plans.

For the buyer:

• The seller can step back in or claim against you. On default, the seller may be able to enforce their security, demand the whole balance or claim under a personal guarantee, which can put your personal assets at risk.
• Repayments in a slow period. Vendor finance repayments come on top of bank repayments, rent and wages. Use our business loan calculator to work out monthly repayments on each loan at the rate and term you expect, then test the total against a slow month or season, not only an average one.
• Limits on running the business. Restrictions can stop you relocating, refinancing or selling until the seller is paid.

When part of the price depends on performance

A variation makes part of the deferred amount depend on how the business performs after the sale. That is an earn-out, and it raises its own questions about what is measured and who controls it. Our earn-outs guide covers them.

Tax

The ATO says that where there is a contract of sale, the CGT event happens when you enter into the contract, not when you settle. With vendor finance, some of the price may arrive in later income years, so the tax and the cash may not line up, and interest also needs to be accounted for. Both sides should ask an accountant how the arrangement affects them before signing. Our guide to the legal and tax steps in a business sale covers GST and the small business CGT concessions.

Questions to agree before you sign

• How much is deferred, over what period, and at what interest rate?
• How often are repayments due, and can the buyer pay out the balance early?
• What happens if a payment is late, what counts as default, and what can the seller do then?
• What security and guarantees will the seller hold, and who will register the security on the PPSR?
• Does the buyer's lender need to approve the arrangement, and whose security ranks first?
• What can the buyer not do while money is owed, and what financial information must they share?
• Can the buyer set off a claim against the seller, such as for a breach of warranty, against the instalments?
• Who ends the PPSR registration once the debt is paid?