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Vendor Finance
Vendor Finance Arrangements Vendor Finance is designed to allow the Pre-Agreed Purchase Price (or any shortfall in the Purchase Price) to be paid over time. In effect, the Vendor finances the whole or part of the Purchase Price by agreeing to accept payment by Instalments. To this extent, it is like "borrowing" the Purchase Price from the Vendor and agreeing to repay it over time. The aim of Vendor Finance Provisions is to determine a timeframe for payment of any shortfall that is:
Pre-Agreement of the Purchase Price When designing a Vendor Finance Strategy, it is helpful to estimate or pre-agree the Purchase Price of the Outgoing Proprietor ’s Equity. This makes it easier to formulate funding strategies for the Pre-agreed Purchase Price now (when there is less emotion involved). For example, if the value of the Equity might be $400,000 at the time of Retirement or Death, the Proprietors can examine the cash-flow implications of:
Examples of Vendor Finance Strategies Below are examples of strategies that deal with situations where:
Bank Loan or Finance One option is to fund any shortfall with a loan from a Bank. However, the parties should not lightly assume that Bank Finance would be available at the time of the Un-funded Event. For example, Bank Finance might not be practical if the Bank was likely to question the amount of the Pre-agreed Purchase Price or the ability of the Purchasers to service the Loan at the time of the Un-funded Event. If this is possible, then the parties should consider Vendor Finance. Bank Loan Funds Upfront Instalment Clover Law often drafts Vendor Finance Provisions that require an upfront Instalment to be paid to the Vendor. It would normally be expected that the Purchasers could fund this Instalment out of their existing resources or by way of Bank Loan. In these circumstances, it would be necessary to dislose the Vendor Finance arrangements to the Bank in order to obtain approval of the Bank Loan.
Some Insurance Cover If the Pre-agreed Sale Price was $400,000 and the only Insurance Cover available was for $200,000, the Vendor Finance Provisions could provide that the Purchase Price of $400,000 will be paid in:
The Vendor Finance arrangements effectively fund payment of the shortfall of $200,000. Once these arrangements are formulated (at least tentatively), the Purchasers can examine the commercial and cash flow implications of funding the shortfall out of their share of the profits of the Business.
No Insurance Cover If the Pre-agreed Sale Price is $400,000 and no Insurance Cover is available, then the parties need to determine whether the Price will be funded by:
Upfront Payment and Instalments The Vendor Finance Provisions could provide that the Purchase Price of $400,000 will be paid in:
Where part of the Price is funded by a Bank Loan, the Purchasers would need to fund both:
Instalments The Vendor Finance Provisions could provide that the Purchase Price of $400,000 will be paid in:
How Many Instalments? The number and amount of the instalments should take into account both:
The decision will usually be a balancing act between the interests of the different parties. However, it is a lot easier to resolve these issues when they are abstract than when someone has actually died or been forced to retire because of ill health. After a death or retirement:
Security Arrangements Because the Vendor is effectively lending the shortfall in the Purchase Price to the Purchasers, there should be appropriate Security Arrangements in place to protect the Vendor against the risk of default.
Fact Finder The Vendor Finance Provisions for any shortfall in the Purchase Price raise similar issues to a Retirement Strategy in which none of the Purchase Price can be funded by Insurance Proceeds. Retirement Strategy Please click the following link to see the Un-Funded Purchase Price Item of the Complete Succession Fact Finder that has been completed for a Retirement Strategy: TPD Strategy Please click the following link to see the Un-Funded Purchase Price Item of the Complete Succession Fact Finder that has been completed for a TPD Strategy which is partly funded by Insurance Cover:
Standard Clover Law Legal Fee Includes Drafting of Vendor Finance Provisions The standard Fixed Legal Fee for all Clover Law Agreements entitles the Business to the drafting of Vendor Finance or other Provisions that deal with the payment of the Pre-agreed Purchase Price or any shortfall.
Progressive Sell-Down Strategy An alternative strategy to deal with Purchase Price shortfalls involves "Progressive Sell-Downs". How Vendor Finance Works? Vendor Finance involves the sale of all of the Outgoing Proprietor's Equity at the time of departure. The Outgoing Proprietor and their Family have nothing more to do with the ownership and control of the Business. However, the Vendors allow the Purchasers time to pay the Purchase Price. Ownership of 100% of the Business gives the Purchasers 100% of the cashflow and profit of the Business. It is this cashflow that allows them to fund the Purchase Price. How Progressive Sell-Downs of Equity Work Progressive Sell-Downs involve the sale of Equity in instalments. For example, a 50% Equity might be sold in five 10% instalments. Thus, there will be a transition in ownership and co-ownership over time:
In this example, the Outgoing Proprietor or their Family continues to be an owner of the Business for the whole of the period. They have joint control and joint entitlement to cashflow and profit. They will be entitled to a share of the profit proportionate to their Equity in the Business in each particular year. Disadvantages of Progressive Sell-Down Strategy It is important to recognise that a Progressive Sell-Down Strategy only partly exits the Outgoing Proprietor from the Business, until the last Sell-Down occurs. It retains the risk of disputes between the Proprietors. More importantly, the share of the profit that is paid to the Outgoing Proprietor by definition can't be paid to the Continuing Proprietors or Purchasers. Thus, the Strategy limits the amount of profit that the Purchasers can access in order to fund the shortfall in the Purchase Price. Conclusion Clover Law normally prefers Vendor Finance Arrangements to the Progressive Sell-Down Strategy. However, the needs of any Business need to be considered on an individual basis.
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Adviser Tip In the case of Retirement, a Complete Succession Plan can pre-agree the Purchase Price and specify a timeframe for payment. If you do not have adequate insurance for an Insurable Event, your Succession Plan can specify a timeframe for payment of the shortfall.
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