Vendor financing, an alternative or ancillary source of funding acquisitions

Vendor finance is a source of acquisition finance which can be used in addition to, or in substitution for, senior debt. Often referred to as ‘deferred consideration’, under a vendor finance arrangement, the vendor effectively loans a portion of the purchase price to the purchaser. A vendor finance arrangement can be useful in circumstances where the purchaser is unable (or unwilling) to obtain senior financing to fund an acquisition. Potential benefits and disadvantages of a vendor finance arrangement may include:

• an increase in the scope of potential eligible purchasers and/or the competitiveness of the sale process;
• generally, vendors will accept that their debt will be subordinated to any senior or mezzanine debt of the purchaser. If the vendor will not agree to be subordinated to senior or mezzanine debt there will be a number of resulting complexities, including, for example, negotiating positions with the senior lender regarding when periodic payments (e.g. payment of interest) may be made to the vendor or when (or whether) the vendor will have the ability to enforce. Such complexities will increase the time it takes to complete the transaction;
• vendors may accept a long term before the loan matures and may accept little or no interest;
• alternatively, the interest rate negotiated between the parties may translate into higher potential returns to the vendor during the term of the loan. Given that the vendor finance is likely to be subordinated, vendors should ensure that the negotiated interest rate is adequate to compensate for this inherent risk; and
• there is the potential in some circumstances for the vendor to be incentivised to continue to be involved with the business during the transition period, allowing for an efficient transfer and continued operation of the business. Given the risk that will continue to be assumed by the vendor during the transition period there may also be an opportunity for the vendor to negotiate receipt of additional benefits (above and beyond the purchase price due to it) during the transition period.

Vendor financing can be documented via a traditional loan agreement, by using a promissory note deed or by incorporating the required loan provisions in the relevant sale agreement. How a vendor finance arrangement is documented will largely depend on the specific transaction being undertaken. Irrespective of how it is documented, it is worth considering whether it is appropriate to incorporate a suite of standard loan provisions, including for example, the requirement for the payment of interest, representation and warranties, undertakings and events of default.

For vendor finance arrangements entered into after 1 July 2018, there may be some benefits to the vendor in documenting the arrangement as a promissory note deed. This is because promissory notes are exempt from the application of the ipso facto reforms, which stay the enforcement of contractual rights upon the entry of a corporate counterparty into certain restructuring and insolvency processes. The explanatory statement to the relevant regulations has indicated that instruments like promissory notes have been excluded from the regime on the basis that failure to do so may prevent financial institutions from enforcing rights based on events of default that are typical and long-accepted in financial markets, which may in turn, adversely affect the ability of companies seeking access to credit. In light of this, it is useful to understand that a vendor financing arrangement documented by way of a bilateral loan agreement would not fall within the exemptions to the ipso facto reforms. It is also worth noting that if the relevant transaction is a ‘contract, agreement or arrangement for the sale of all or part of a business’, the contract (whether it is documented as a promissory note or otherwise) will also fall within the exceptions to the ipso facto reforms. The inclusion of this exemption is based on the importance placed on instilling confidence in early negotiations around the sale of distressed business as making those transactions more difficult would inhibit the chances of the distressed company’s success and would, therefore, be directly contrary to the purpose of the reforms.

Vendor financing can be either unsecured or secured against assets of the purchaser. If secured, additional security documents will be required and priority arrangements will need to be negotiated with any third party security holders. Vendor financing may be an option worth considering where financing gaps arise in order to ensure that acquisition transactions are closed in a timely and efficient manner.

If you would like any further information on any aspect of vendor finance, please don’t hesitate to contact Wright Legal.

The material in this article is provided only for general information. It does not constitute legal or other advice.