Vendor finance arrangements are common when selling an accounting practice.
Vendor Finance Arrangements
In this episode Geoff Stein of Brown Wright Stein Lawyers in Sydney will discuss ten questions about vendor finance arrangements (VFAs) with you, focusing on VFAs for accounting and tax practices.
Here is what we learned but please listen in as Geoff explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
Vendor Finance Arrangements
At the start it sounds very tempting. You pay a deposit and the rest of the purchase price gets financed out of sales while you already run the practice. But that is a huge potential for conflict.
Here are ten questions and answers to better understand VFAs in general as well as why there is so much potential for conflict.
1 – More common now?
Banks have always struggled to finance the purchase of a professional practice. There is little brick and mortar or tangible equipment, and mostly just intangible client lists, staff and know-how, making it harder for banks to find security.
Hence vendor finance arrangements have always played a large role when selling a practice, not just now after the Royal Commission.
2 – Whole purchase price or just a portion?
Vendor finance arrangements rarely involve the entire purchase price, but usually only a portion of the price.
3 – Higher purchase price or interest?
There is no such thing as a free lunch. A vendor finance arrangement represents risk for the seller. And that risk is usually reflected in a higher purchase price.
In theory the loan could earn interest, but this is rarely how it is structured. Usually, the loan is interest free and instead the price is inflated accordingly.
4 – Debt or Equity?
There are two types of vendor finance arrangements: debt VFAs and equity VFAs. However, the later is extremely rare. Most VFAs are debt VFAs.
5 – VFA more expensive than a loan?
It is difficult to tell whether VFAs are more expensive than the interest you would pay for a bank loan, since the cost of the VFA is hidden within an inflated purchase price. So difficult to say how much of the purchase price is for the VFA.
6 – Accounts receivable in a share sale?
In a share sale the accounts receivable stay with the company. So the sales price of the shares is adjusted based on how much of those A/R is recoupled
7 – Accounts receivable in an asset sale?
In an asset sale the A/R usually stay with the seller and the buyer just collects the monies on behalf of the seller. So the vendor keeps some legal hold over AR.
8 – Is it common that a seller can cancel a VFA?
The option to cancel in a VFA usually covers the scenario where the buyer doesn’t pay their instalments on time. And the reason for that is usually that the practice doesn’t generate cash the way the buyer thought it would. And so there isn’t sufficient cash to pay the vendor out, so all implodes.
9 – What happens to AR in case of a cancellation?
If the seller cancels the sales and VFA contract, what happens to past and present accounts receivable all depends on the contract and the interpretation of that contract.
But what happens if the contract doesn’t cover this? Then you have to refer to common law, ie. previous court case rulings.
And there is one court case that is particularly relevant to this. It is the High Court judgement in BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 180 CLR 266 at 282-3.
In this case the barrister successfully referred to implied terms and argued that exit debtors are owned by the buyer on the firm.
Per the court ruling, there are five tests to determine whether exit debtors stay with the buyer when a sale with VFA is cancelled. They stay with the buyer, if this is
- reasonable and equitable;
- necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it;
- so obvious that “it goes without saying”;
- capable of clear expression;
- not contradicting any express term of the contract.
10 – Do VFAs provide more possible points of contention?
Definitely. All contracts provide a breeding ground for contention. And in a VFA you have three contracts and not just one, hence three times the potential for conflict.
A vendor finance arrangement usually involves three contracts: 1 – the actual sale of the practice, 2 – a loan for parts of the purchase price and 3 – the previous owner’s involvement during a transition period.
So in summary, vendor finance arrangements are a good way for buyer and seller to finance the transaction, but pay attention to the fineprint.
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