3 possible scenarios for a spread payment in a business transfer

When selling your business, many factors come into play, including payment terms. Buyers often want to pay the purchase price in installments or postpone part of the payment. What is wise and what are the risks? In this article, we'll discuss the pros and cons of deferred and installment payments in business transfers.

1. Installment payment when selling your business

Our advice: Don't accept it: the risk of non-payment is (too) high.

Imagine you have a potential buyer proposing to pay 1/5 of the purchase price annually.

Risk of non-payment of the installment plan
Suppose your buyer abruptly stops paying a year after the takeover, claiming that the inventory doesn't match the assessed value at the time of sale or that the staff is not competent. Both are "excuses." Inventory can vary, such as the number of wine bottles in a restaurant never exactly matching the inventory list. This isn't necessarily fraud; think of bottles given as gifts, broken, or stolen.

The claim that the staff is incompetent or unmotivated is very subjective and open to interpretation.

Legal action

As a business owner, you can take legal action to demand payment of due sums, but this is not straightforward in a business transfer:
A summary judgment is not an option. The reasons for non-payment—like inventory management or incompetent staff—are linked to the contract's basis, while a summary judgment deals with temporary measures only.

A full court proceeding becomes the only option. However, this process can take months or even years, with the risk that your sold business might cease to exist in the meantime.
Conclusion: As a seller, you take a (too) significant risk when agreeing to a payment plan for the full purchase price.

2. Postponed payment of part of the purchase price

Our advice: Consider in some cases.

The postponed payment is either unconditional - referred to as a vendor loan - or conditional based on the company's performance - known as an earn-out.

In both cases, the buyer pays part of the purchase price later.

Every seller wants to receive the full purchase price immediately at the business transfer. However, as a seller, you should realize that the buyer often wants you to co-finance part of the deal through postponed payment.

For instance, the buyer might finance part of the acquisition from future profits (earn-out), or the seller might extend a loan, a so-called vendor loan. In both cases, the buyer pays part of the purchase price later, enjoying a partial payment delay.

A vendor loan has specific pros and cons

There are significant differences between an earn-out and a vendor loan. In an earn-out, the purchase price depends on the company's future performance, whereas in a vendor loan, the purchase price is fixed.

The vendor loan

A vendor loan is a way to delay payment, where the seller extends credit to the buyer. This might be useful if a bank believes the buyer doesn't have enough equity for the full loan. Additionally, a vendor loan helps keep the seller involved for a smooth transition and sends a positive signal to other financiers.

While advantageous for both parties, a vendor loan carries risks. Especially if the buyer relies on this loan for financing, caution is warranted. The seller must assess not only the buyer's creditworthiness but also the entire financing structure.

A significant drawback is that a vendor loan is often subordinated to bank financing. This means the seller is paid last in case of bankruptcy. Hence, it's wise to accept a vendor loan only for a limited amount, like 20% of the purchase price.

Advantages of a vendor loan

A vendor loan offers benefits, such as improving your business's salability and signaling strong trust to bankers, facilitating financing. Due to the higher risk, you can negotiate a higher interest rate.

Legal aspects

• Ensure agreements that safeguard loan repayment, such as restrictions on dividends and management fees.
• Establish that the vendor loan is immediately callable upon buyer's non-compliance.
• Include a 'change of control' clause in case of resale by the new owner.

The earn-out

An earn-out can be attractive for both parties during a business transfer but also brings risks of disputes. These arise when an earn-out is used to bridge price expectation gaps. Clear parameters in the acquisition contract and realistic seller expectations can prevent many arguments. However, the seller has little influence on future company results post-sale, making earn-outs complex to implement.

Also read: How can I help the buyer of my business secure takeover financing?