The vendor financing model is built on the concept of strong business relationships. For buyers, vendor financing can help secure goods or services and improve their credit history without needing to seek a bank loan. For sellers, vendor finance arrangements can help make sales they otherwise wouldn’t, as well as build increasingly trustworthy and profitable links with their clients.
It’s a mutually beneficial trade-off that many established buyer-seller relationships work off in business, but that doesn’t mean it’s always the best solution. In this guide, we’ll look at what vendor finance is, how it works, the pros and cons, and whether it’s a suitable route to go down for you as a customer.
Vendor financing, otherwise known as trade credit, is a type of loan agreement where a vendor lends money to a customer who then uses that loaned capital to purchase that vendor’s products or services. It’s an arrangement used by vendors to maintain and strengthen valued relationships with clients who don’t have the cash flow or working capital in place to otherwise make the purchase.
In most instances, an established trade relationship will need to be in place for a vendor finance agreement to be made. While it’s not necessarily the ideal scenario for either party, it allows the vendor to make a sale and fortify the customer relationship, while the borrower can secure the products or services they require without having to seek external funding – which often requires some form of collateral to be offered.
Vendor finance usually takes the form of a deferred loan (which postpones any interest payments until a predefined date) for the vendor. A typical vendor finance agreement would see the customer pay a deposit to the vendor to secure the finance, then pay back the loan amount via a series of regular payments. As and when vendor finance interest rates are added, customers can expect to pay around 5-10% on top of their repayments.
Vendor finance in the UK does not require the borrower to meet any applicable lending criteria. The arrangement is made without the involvement of banks or other lenders, meaning the borrower’s credit history is, on paper at least, a minimal factor in the vendor’s lending decision.
This does, however, mean that interest rates on vendor loans can be higher than traditional financing alternatives, though often vendors will keep interest rates down or nullify them completely to incentivise a purchase and strengthen their links with the client.
There are two primary types of vendor financing: debt financing and equity financing.
With debt vendor finance, the borrower agrees to pay a set price for goods or services with an interest charge attached. The amount is either paid off over time or, if the borrower fails to make repayments over an extended period, the loan is written off as a bad debt. In the latter instance, the borrower is then not allowed to enter into future vendor financing agreements with the seller.
Equity vendor finance involves the borrower offering up an agreed amount of company shares in exchange for goods or services, instead of repaying in cash. This process makes the vendor a shareholder in the borrowing business, meaning they will receive dividends for as long as they hold the shares and even potentially have a say in how the company is run.
Start-up companies often rely on equity vendor finance to invest in the goods and services they require or use inventory financing, which uses their inventory as collateral against a short-term loan or line of credit to buy said goods.
Vendor financing effectively offers the next best solution to vendors and customers when the customer business’ purchasing capital is insufficient. It’s an arrangement that offers benefit to both parties involved, but there are also some pitfalls of vendor finance to consider as a potential borrower.
You’ll find vendor finance examples in a broad spectrum of sectors across the commerce and industry picture. Common industries for vendor financing include security, maintenance, and payroll management, but also a wide variety of business to business (B2B) operations such as office equipment suppliers and various forms of material and parts suppliers.
H2: Does vendor financing make sense for you?
If you need to purchase essential goods and services but don’t have the cash flow or working capital to do so, vendor finance can provide a useful outlet for funding that forgoes the need to approach a bank or another financial institution.
If, however, you don’t want to run the risk of higher interest rates or don’t have established buyer-seller relationships to rely upon, vendor finance becomes a much less viable option.
At Nucleus, we offer several lending formats that provide valid alternatives to vendor finance. From asset-based lending to cash flow finance and business growth loans, we can help you get the funding you need. To find out more, contact us today.
4 August, 2022