The Benefits and Risks of Vendor Financing for New Zealand's Hospitality Businesses

Kia ora! If you're considering purchasing a hospitality business such as a cafe, restaurant, or bar in New Zealand, understanding the nuances of vendor financing will be a game-changer. In this post, we'll cover just what is vendor financing, when is it suitable and not suitable, who stands to gain what, and then dive into the detailed mechanics of how these deals are typically structured.

What Even is Vendor Financing??

Vendor financing, also known as seller financing, is a method used in business sales in New Zealand where the vendor extends credit to the purchaser to facilitate the purchase of the business. Instead of the purchaser obtaining a loan from a traditional financial institution, the vendor allows the purchaser to make payments over time, usually with interest. This can be an attractive option for both parties: for the vendor, it can make the business more appealing to potential purchasers and potentially fetch a higher sale price; for the purchaser, it can be a more accessible financing option, especially if traditional bank financing is difficult to obtain.

Is it Common?

Vendor financing, while not exactly common, has a growing place in the sale of businesses in New Zealand. Traditional bank lending processes changed significantly after the introduction of new lending regulations in 2022. As a result, vendor financing is gaining traction in the sale of hospitality businesses, offering a practical alternative to the conventional banking route.

What are the benefits?

Benefits for the vendor

The primary benefit for the seller is enhancing the business's affordability to a broader array of buyers. This expansion in the buyer pool significantly boosts the likelihood of a sale and can lead to a more advantageous selling price.

Expands Purchaser Pool: Broadens the range of potential purchasers.
Exudes Confidence: Demonstrates your belief in the business's success.
Enhances Market Appeal: Differentiates your business from competitors.
Interest Earnings: Generates income at a risk-adjusted rate.
Clear Terms: Offers transparent and agreed-upon contractual terms.
Facilitates Sale: Increases the likelihood of a successful transaction.

Benefits for the Purchaser:

Eases Financing: Simplifies the process compared to traditional bank loans.
Speed and Simplicity: Offers a more straightforward transaction process.
Vendor Confidence: Indicates the vendor's trust in the business's potential.

How are Vendor Financed Deals Structured?

There's no one-size-fits-all approach, it varies greatly depending on what is needed to get a deal done. Here's some of the options:

Vendor Loan: Traditional and Straightforward: For those seeking simplicity, the vendor loan method is a classic. Regular payments, including both principal and interest, are made from the purchaser to the vendor over a set period until the debt is fully settled. This clear, predictable structure is the most commonly used in hospitality business sales. It's appealing for its transparency and ease of understanding.
Earn-Outs: This method is especially pertinent in other sectors with higher business values known for variable cash flows. With earn-outs, part of the purchase price is paid upfront, while additional payments are contingent on the business's future performance. This structure offers purchasers a safety net, ensuring they only pay the full price if the business continues to thrive post-acquisition. This structure is not common in hospitality business sales, as it can be high risk for the vendor.

The conditions around vendor finance are detailed and agreed in the business sale and purchase agreement, and associated documentation prepared by the solicitor.

Some of the usual terms to be considered in this documentation includes;

Loan Amount: Specify the sum to be financed by the vendor.
Interest Rate: Set the rate for the financed amount.
Repayment Period: Determine the time frame for full repayment.
Payment Frequency: Agree on how often payments will be made.
Security: Identify security, like property, for the vendor (more on this below).
Reporting: Define the purchaser's financial reporting obligations.
Missed Payments: Outline procedures for handling missed payments.
Legal Costs: Decide who bears the legal expenses, typically the purchaser.

Understanding Vendor Financing Limitations:

While vendor financing can be an attractive option, it's important to recognise that it's not suitable or possible for every transaction. The feasibility of vendor financing depends on several factors:

Vendor's Financial Position: Some vendors may require immediate cash from the sale and cannot afford to wait for future payments, particularly where there is debt to be repaid upon a sale, or the owner is of retirement age.
Risk Appetite: Vendor financing carries a risk for the vendor, as they become dependent on the purchaser's success in running the business. Not all vendors are comfortable with this risk.
Market Conditions: In a seller's market, where demand for businesses is high, vendors will likely prefer purchaser who can pay upfront rather than relying on vendor financing. Having a component of vendor finance in your offer may present as a weaker option to the vendor.

Security for the Vendor

Securing vendor finance deals may or many not involve legal and financial mechanisms that protect the interests of both the purchaser and the vendor. The structure of these deals can vary depending on the specifics of each transaction. Here are the common ways to secure vendor finance deals in this context:

General Security Agreement (GSA): In New Zealand, a General Security Agreement is often used. This grants the vendor a security interest in the assets of the business. If the purchaser defaults, the vendor can lay claim to these assets. The GSA is registered on the Personal Property Securities Register (PPSR).
Personal Guarantee: Especially in transactions involving smaller businesses or higher risks, the vendor might require a personal guarantee from the purchaser. This makes the purchaser personally liable for the debt if the business cannot meet its repayment obligations.
Mortgage over Real Property: If the transaction includes real estate, a mortgage can be used to secure the loan. This gives the vendor rights over the property if the purchaser defaults on their payments.
Life or Key Person Insurance: The purchaser may be required to take out a life or key person insurance policy, with the vendor as the beneficiary. This ensures that if something unforeseen happens to the key individuals running the business, the vendor's financial risk is mitigated.
Conditions: The sale and purchase agreement will typically include various conditions. These might stipulate that the purchaser must maintain the business to certain standards, achieve specific financial targets, or seek the vendor's consent before making major business changes.

It's important for those vendors and purchasers involved in vendor finance deals in New Zealand to work with legal and financial professionals who are familiar with vendor financing to offer the best advice around protection.

Final thoughts...

Vendor financing isn't just about the financial transaction; it's about building a bridge between the aspirations of purchasers and the goals of vendors. It's about creating opportunities where traditional methods fall short.

Are you considering buying or selling a hospitality business in New Zealand? Interested in exploring how vendor financing might work for you? Reach out to us for a confidential, no-obligation chat. We're here to help.

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