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Vendor loans can be useful but should be a last resort

Vendor financing can give rise to certain tax considerations that also need to be carefully considered

You want to sell your business. How far should you go to help someone to buy it?

“Ideally what you want when you are selling is to sell 100 per cent of the asset for 100 per cent of the value at the same time. So vendor finance is not at all common,” says Peter Bennett, head of investment technology banking at corporate financial adviser Davy.

“It should be seen as a last resort made to get the deal done. It’s a useful tool where a situation occurs that you have a single buyer who is a very compelling buyer in all respects other than a lack of finance.”

That most commonly means management buyouts. “MBOs typically require either external capital or the vendor is more patient about receiving its proceeds. Vendor loans can create a win-win situation for some sellers as MBOs can be less disruptive to the business and managed appropriately can allow the successful transition of a business from one generation of executives to another,” says David O’Kelly, head of M&A at KPMG.


But vendor finance might also arise “where all other buyers have disappeared and you are left with just one, but that single buyer doesn’t have the means to reach the amount you want”, says Bennett. “You’d also often see it is where a company is selling a division.”

Sellers may wish to provide a vendor loan where they have to sell their business or part of their business at short notice, perhaps for regulatory reasons, and there isn’t time for purchasers to raise sufficient third-party funding to execute a transaction, says Laura Gilbride, director PwC corporate finance.

“While typically described as loans, they usually have characteristics which are more akin to equity. The loan will rank behind senior debt and may have an increasing rate of interest which encourages the purchaser to repay the loan sooner,” she adds.

“In situations where there is a formal process, the market will set the value range for the business. In bilateral situations, both the buyer and seller will initially come up with their respective positions and from there attempt to negotiate an agreed price. Where the price ends up depends on the relative strengths of each party,” says Gilbride.

Each situation is unique and vendor finance should be assessed on a case-by-case basis, says Colm Sheehan, a director of corporate finance of accountancy firm Crowe. “It generally works best where the vendor will retain some role in the business post-sale or where the vendor is financially secure and is happy to defer an element of the consideration.”

It is important to agree the commercial terms of the loan at an early stage, including the repayment timeframe, cashflow waterfall if other lenders are involved, and any security which will be available to support the loan.

“Vendor finance is, in effect, a form of deferred consideration attached to the deal. Ensuring that there is an appropriate level of upfront consideration paid by the purchaser and that the deferred element is not contingent on future performance targets or thresholds will mitigate your exposure,” he says.

Make sure the security package attached to the loan is robust. “In the event of borrower default, it will be important that you have the capacity to recover your loan in the same manner that a third-party lender would have. This could be in the form of a charge over all shares in the business, and personal guarantees from the borrowers,” adds Sheehan.

The structure of such transactions can bring challenges for both parties.

“Expensive interest payments on the vendor financing can weigh on the business being sold and prevent the business from having sufficient capital in the future to further invest in the business,” points out Brian McCloskey partner in law firm Matheson’s Corporate M&A Group. “From the seller’s perspective there is a risk that the performance of the target business deteriorates and there may be a delay in having the vendor financing repaid or in a worst-case scenario, the seller is never repaid.”

Vendor financing can give rise to certain tax considerations too that need to be carefully considered. These include the ability of the seller to avail of CGT “rollover relief” on a disposal of a portion of their shares not being sold for cash. Says McCloskey: “In addition, certain provisions may need to be considered which, in certain circumstances, can recharacterise share proceeds as distributions for Irish tax purposes which can impact the seller’s tax position and the buyer’s withholding tax analysis.”

Buyer’s beware, vendor finance could see the seller seek to restrict the new owner’s ability to run the business autonomously for the period in which the vendor financing is outstanding. That, he cautions, may hinder the buyer’s ability to expand the business over time.

Sandra O'Connell

Sandra O'Connell

Sandra O'Connell is a contributor to The Irish Times