Published on Nov 14, 2019

As traditional funding gets more difficult to obtain, more buyers are looking to sellers to provide vendor finance As traditional funding gets more difficult to obtain, more buyers are looking to sellers to provide vendor finance

Even though interest rates are going down, the traditional funding market for business is tightening, making funding more difficult to obtain for anyone purchasing a financial advice business. This is leading to a desire for buyers and sellers to explore other options like vendor finance.

The lending market is tightening

Traditional lenders in the financial services space are currently reassessing their appetite for funding deals for smaller advice businesses. Changes to remuneration structures for advice businesses (including clawbacks to revenue) and defaults by existing borrowers, are affecting the willingness of banks to fund these acquisitions. The upshot is that some transactions are being delayed but, in the worst cases, where buyers are unable to fund acquisitions they’ve already entered into, those acquisitions are being terminated.

Sometimes the nature of the buyer’s business is the reason why they can’t get finance. For example:

  • If the adviser is setting up their advice business for the first time and does not have a track record of managing a client portfolio; or
  • Where the size of the buyer’s business is such that the bank requires collateral in the form of a mortgage over property, but the buyer does not have the supporting assets and equity in line with the bank’s requirements.

Finding out early on the status of finance applications, and whether the buyer is pre-approved, is important.

The days of funding against the recurring revenue of the client book without other security seem to be over.

Whilst buyers reliant on finance will include finance conditions in their purchase contracts, these other factors (often outside the buyer’s control) put the seller’s position at risk.

A potential solution is vendor financing.

What is vendor finance?

Vendor finance is where the seller funds all or a part of the purchase price. The buyer pays a deposit on completion and then repays the balance (with interest) over an agreed period of time via regular repayments. Essentially, it is a loan between the buyer and the seller.

This approach is particularly useful when the purchase price is paid by instalments over a lengthy period (i.e. 2 or 3 years) and recalculated when each tranche for payment is due.

Vendor finance can be used to fund the book purchase entirely, but buyers may want to restrict it to funding the first instalment, so the revenue earned from the purchased book can be used to service the loan. Then once retained and ongoing revenue has been demonstrated, the buyer can often obtain traditional funding from a bank/financier to cover the balance. This is also optimised when the subsequent instalments are much smaller percentages of the overall purchase price.

Vendor finance ensures that both the seller and the buyer remain committed to the purchase:

  • The seller will be motivated to ensure that the clients move across to the buyer as their new adviser; and
  • The buyer will need to actively service those clients to maintain the revenue earned from the book to make the repayments to the seller.

The buyer benefits from vendor finance by being able to fund their purchase. It also gives them some comfort that the seller believes the revenue stream from the book will continue and some assurances as to the quality of the advice and client base.

For the seller, vendor finance means that the sale actually goes ahead. It also means they can get their asking price. This is particularly relevant because buyers often try to negotiate a lower multiple or reduced purchase price when financing is difficult to obtain. Of course, vendor finance cannot be used effectively for a seller who needs most of their purchase price immediately and cannot be ‘drip-fed’ the purchase price over a longer period (e.g. retiring brokers who need the payment for their superannuation or to fund another business opportunity).

How do you structure a deal with vendor finance?

Any seller that is providing vendor finance should at a minimum:

  • Require security over the buyer’s assets (for example, a deed of grant of security interest to make sure the seller can take the client book back if there are defaults). This includes registering the seller’s interest on the Personal Property Securities Register.
  • Undertake some targeted due diligence on the buyer, as noted in my earlier blogs on Warranties and Indemnities and Managing the Risk of Recovery. This will help the seller understand the buyer’s financial position and make sure the assets over which the security is granted are sufficient (should the seller need to make a call on the security).
  • Consider personal (owner/director) guarantees as well.

As with any debt financing arrangements, the vendor finance terms should also be adequately recorded. This can be done in the sale agreement and should include details about:

  • The security arrangements;
  • Repayment schedule;
  • Interest rate;and
  • The process upon default. This may include granting a power of attorney so the seller can step in and regain control.

If the plan is to seek to convert to a traditional finance source during the vendor finance term, this should be explored by the parties prior to formalising the agreement, so that:

  • Appropriate provision and flexibility to facilitate the switch is included in the agreement; and
  • Forethought is given to anticipated financier considerations, so that those can be managed at the time of initial due diligence. For example, financiers are looking more closely at client ownership and licensee arrangements.

As the lending market tightens, financiers are looking more closely at sale/purchase agreements. I expect this practice will only increase moving forward. Financiers are interested in making sure that the buyer is getting what they pay for so that the financier has comfort that the debt can be serviced. So it’s important that the documentation is adequate and clearly states each party’s rights and obligations.

If you’re considering offering or accepting vendor finance, it’s best to get legal advice before you sign the contract. Get in touch with us, we’d be happy to help.

Katie Johnston

November 2019

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