Vendor Finance Guide: What is it, and Should You Get Involved?
21 Oct 2019
Vendor financing is when the buyer receives a loan from a vendor, which will then be used to buy the vendor’s service or inventory. For instance, let’s say the inventory we’re looking to buy costs $1000, yet we only have $400. The seller will loan us the remaining $600 that we’re missing, but with a certain interest rate. Afterward, the loan can be paid over time, or part of the shares will be transferred from the customer to the vendor. Some people, because of bad experiences they’ve had, believe vendor finance to be a risky call. We’ll explore how vendor finance works, then you can decide for yourself if it’s something you believe is worth taking up.
Types of Vendor Financing
Firstly, we can roughly differentiate between two types of vendor financing or vendor funding. In debt financing, the borrower or buyer will receive the products at a sales price with an agreed interest charge. This is done mostly for office supplies, computers and such.
When it comes to equity financing, the vendor becomes a type of shareholder. They provide the goods needed by the borrower in exchange for an agreed-upon amount of the borrower’s stock. Therefore, the vendor is paid in shares and no cash is used when covering the loan. Depending on the loan size, the lender will receive dividends and participate in large decisions in the borrower’s company. This may not be a good strategic choice for experienced businessmen, but is a common move for new companies; they haven’t had a chance to build credit with banks or proper lenders, and they may need advice that comes from someone experienced.
In both situations, if the loan is not repaid the interest charge will increase. If it isn’t paid until the deadline, it is considered bad debt and the buyer will be unable to enter another arrangement with the vendor. As the buyer, make sure that your payments are on time. The seller, however, also has a duty of being proactive in payment collection so as to avoid any future issues.
When Vendor Funding Should be Avoided
There are certain dangers when it comes to these types of loans. If you buy a property from a vendor for a large sum, its market value might drop over time, but the value of your debt won’t. There are several laws concerning vendor financing, but the biggest part of the exchange is unregulated. This is especially important in situations where the ownership of a company is being traded.
We’ve already mentioned how the vendor will be able to make decisions in the borrower’s company, and in some cases, they can take complete ownership. If you’re entering an agreement where your name isn’t included in the property title, you shoulder enter a contract that will protect you when the debt is paid off. However, the benefits of seller financing outweigh the negatives as it sits among the better asset finance solutions.
In some situations, financial institutions will be unwilling to lend money to a business or individual. This is mostly because the business is new and doesn’t have established credit, or the individual does not have a good history with the bank itself. A vendor can help buyers in these situations by giving out a loan but the rate of interest is often higher. These types of debts can also be paid off using business profits, which is an incredible advantage for the buyer. This means that you may not need to expend personal funds if sales is proficient enough.
Vendor finance is a great asset in situations where you can’t provide a deposit at around 20% of the purchase price, which is the amount most lenders ask for. Instead of such a large loan, you will be given time to get your finances in order, and this flexibility is often the help most people need.
As mentioned prior, banks usually don’t give out loans to untrusted individuals, or groups with poor credit rating. If you’re unable to qualify with a financial institution, vendor funding is a viable option.
Trust Your Partner
Some companies that provide all sorts of equipment and specialize in these types of loans. Finding a partner you can trust is important, especially if you’re a starting business. An offer can become more affordable, tax can become less of a burden, and there is always the flexibility of being able to pay off the loan over time. The biggest part of vendor finance rests on personal guarantee, and both parties should be able to abide by some requirements. If the company you’re asking for a loan is a bit murky or unknown, you should guard yourself properly.
Vendor finance is a term used to describe a method where a vendor assists the borrower in buying the vendor’s inventory. This, of course, comes with an interest rate that may increase over time. The burden is partially lifted by business profit, however. Depending on your plans for the future and the overall success of the company, the profit will be larger and again, the loan is easier to return. If you’re unsure of your future endeavors, the loaner can advise you as they’ve become part of your business, in a sense. To sum up, vendor funding is generally accepted, especially so in new businesses that may need the initial push to get things started.