Thinking about offering vendor finance to sell your property or business? Before you agree to become the bank, make sure you know how to protect yourself if the buyer cannot pay.
With traditional bank finance becoming harder to obtain, vendor finance can be an attractive option for both sellers and buyers of property or businesses. For a seller, it can broaden the pool of potential buyers, provide an income stream from interest and help achieve a sale where conventional finance is unavailable.
But there is a catch: when you provide vendor finance, you are no longer just selling your property or business — you are lending money.
That means you need to think like a bank.
What is vendor finance?
Vendor finance is an arrangement where the seller effectively finances some or all of the purchase price for the buyer, rather than requiring the buyer to obtain all of the funds from a bank.
The most common way is for the buyer to take ownership of the property or business and give the seller a mortgage securing the unpaid purchase price.
The biggest risk: the buyer does not pay
Perhaps the property or business income drops. Interest rates increase if they are also lending other monies from a bank. There is an interruption to operations (perfect example – Covid). The buyer becomes ill, loses employment or simply takes on more debt than they can afford.
Whatever the reason, the seller can suddenly find themselves chasing a substantial debt while the value of the property, business or other secured assets may have fallen.
The answer is to build layers of protection into the transaction from day one.
Think like a bank
Before agreeing to vendor finance, conduct the same due diligence that a bank would undertake.
Ask:
What assets does the buyer own?
What income do they receive?
What are their living and business expenses?
What other debts do they have?
What is their credit history?
Do they have stable employment or reliable income?
Can they comfortably afford the proposed repayments?
What happens if interest rates rise (if they are sourcing some funding from a bank)?
Do not simply rely on the buyer telling you they can afford the loan. Verify it.
Obtain financial statements, tax returns, bank statements, credit reports and evidence of income. If the buyer is purchasing through a company or trust, investigate the people behind the structure as well. Ask your Accountant to help you review the Buyer’s ability to repay the loan.
Take security
The seller's first priority should generally be a first or second registered mortgage over the property securing the amount owed, together with interest and enforcement costs.
A registered mortgage gives the seller a strong security position over the land and can provide rights to enforce the debt against the property if the buyer as borrower defaults, subject to the applicable Queensland legislation.
But do not stop with the land.
The buyer's other personal or business assets, including vehicles, plant, machinery, equipment, livestock, receivables and other personal property may also have substantial value. A security interest over those assets should be documented and registered on the Personal Property Securities Register (PPSR).
Get personal guarantees
If the buyer is a company or trust, do not assume that the entity's assets will be enough.
Find out who is really behind the purchase.
For a company, investigate the directors and shareholders. For a trust, investigate the trustee, beneficiaries and the people who control the trust.
Consider requiring the appropriate individuals to provide personal guarantees for the buyer's obligations. Ask the guarantors for their income, assets and liabilities too.
A guarantee gives the seller another avenue for recovery if the borrowing entity cannot pay. Depending on the circumstances, additional security over the guarantors' assets may also be considered.
Insurance can protect against the unexpected
Consider what happens if the buyer dies, becomes ill or loses their job.
The buyer should have appropriate insurance over the property/business and its improvements. Depending on the circumstances, this may include:
property and building insurance;
public liability insurance;
business interruption insurance;
life insurance;
total and permanent disability (TPD) insurance; and
income protection insurance.
The seller should consider requiring appropriate policies to remain in place for the term of the vendor finance and ensuring the seller's interests are noted on these policies.
The objective is simple: if something happens to the buyer, there should still be a realistic pathway to repayment.
Vendor finance can work — if you treat it like lending
Vendor finance can be an effective way to facilitate a property or business sale, provide an interest return and help a buyer who cannot immediately obtain conventional bank finance.
But the seller should never forget what they are doing.
You are becoming the bank.
Conduct proper due diligence to ensure that the buyer (as borrower) has a good chance of paying you back. Obtain a first registered mortgage wherever possible. Register appropriate PPSR security. Obtain personal guarantees. Require suitable insurance. Make sure the loan documents contain strong default and enforcement provisions.
Most importantly, do not wait until the buyer stops paying to think about how you will recover your money.
The best time to protect yourself is before you agree to loan the money.
Who Can Help?
Our Commercial Property Lawyers at Statewide Conveyancing can assist you with not only your property or business sale but also drafting and negotiating the terms of Loan Agreements, Mortgage Documents and Security Agreements for your Vendor Finance Arrangement.
For more information, talk to one or our experienced team members today!
The content of this article is intended to provide a general guide to the subject matter and is not legal or financial advice. Vendor finance arrangements can have significant legal, financial and taxation consequences. Specific advice should be obtained in relation to your particular circumstances before entering into any vendor finance arrangement.