From property acquisition, business expansion, and hiring sprees, to equipment repairs, maintenance costs, and keeping up with demand – running a business is difficult. It is the art of mastering the juggling act of ongoing bills, financing agreements, and beyond. Many companies do not have the capital to spare for an outright purchase of a few extra delivery trucks, a new warehouse, or significant industrial equipment. That is why business financing options are crucial to long-term growth. Vendor programs, also known as vendor financing programs, allow businesses to acquire inventory or new equipment by buying it with money borrowed from the same vendor.
In other words – yes, certain vendors will pay you to buy their product. The catch? You must pay them back with interest. The main benefit of a vendor financing deal is that you are not borrowing money from a bank. The vendor and customer business can facilitate any business-to-business agreement they choose, setting their repayment terms and interest rates. When negotiating with a vendor, you are more likely to persuade them to offer you a deal than a bank might. This preserves credit, but it protects your cash flow and improves the negotiation options on the table. The catch? It may cost more.
Vendor Programs for New Equipment Financing
The primary use of a vendor program is to facilitate the acquisition of new equipment. New equipment can be expensive, whether it is multiple dozen pressure washers for a few thousand dollars a pop or a 300-horsepower bulldozer for well over a million. Companies that have that kind of capital typically do many other things with it, like expanding the business or making an investment you cannot easily borrow for. And if you do not have that capital, it makes more sense to take out a loan than sell assets to buy equipment outright.
Not only will selling investment assets potentially result in a capital gains tax, but it makes little sense to cut into your company’s equity when you are in a stable enough position to take on the debt of a new equipment financing agreement and benefit tremendously from it. Most financial institutions, large lenders, and banks are more than willing to give an established business with good credit a lot of money to use on expansion, then pay off over time with interest. But why opt for a vendor program over any other type of equipment financing? There are a few reasons. Vendor financing programs provide:
- Greater flexibility on behalf of both partners.
- Alternative financing without having the leverage to take out a loan of equivalent size.
- Vendors with a significant profit, and can demand a higher interest rate than a bank would.
- Buyers with new equipment they otherwise would not be able to afford.
Some vendor financing agreements utilize a deferred loan. This means the interest on the loan payments does not start accruing until the end of a certain period, like the first 6-12 months. While the buying business benefits from being able to pursue an alternative financial agreement – especially if they are not eligible for a loan that size from their bank – the vendor benefits from a sale with interest, a nearly guaranteed purchase, future business, and the flexibility to set the terms they need to satisfy the risk they’re taking (which can include significant security options).
Entering a Vendor Financing Program
Younger businesses who might not have the option to pursue an equipment loan or lease the traditional way may still have a shot at negotiating a vendor financing agreement by offering specific security options to satisfy the vendor’s risk. These include:
- The ability to take charge of the business in the event of loan default.
- Mortgage over business properties or assets.
- A deed of priority, placing the vendor over any other creditor.
- Monthly or quarterly financial reports to help vendors oversee the health and security of their investment.
- A director’s guarantee.
In addition to offering debt financing – wherein a vendor provides most or part of the funds needed to buy their equipment – some vendors may also agree to equity financing. This is an alternative means of securing the debt and providing potentially more significant value to a vendor, especially in an established business – a stake in the company, stocks, or shares. However, promising startups can also use equity financing to obtain equipment from a vendor. Not only does this help a new business preserve cash flow and avoid having to take the traditional route and risk rejection from the bank, but it also provides startups with the opportunity to establish a relationship with a significant supplier.
Having a substantial supplier as a stockholder in the company gives them the incentive, later down the line, to offer favorable terms, and benefit from the continued success of the business (and their investment). The borrowing business does not need to worry about cash repayments, and the vendor does not need to worry about a defaulting buyer. There is an additional risk here – obtaining equity in a failing business is worthless. Still, if a vendor does their due diligence and accepts the chance, it could provide a much greater ROI than simply wanting cashback alongside interest.
Risks and Benefits of Vendor Programs
Vendor programs are not without inherent risks, both for the vendor and the prospective buyer. We know vendor financing helps businesses:
- Obtain new equipment;
- Form new relationships with significant suppliers;
- Obtain a loan they would not qualify for with a bank;
- Build credit for their business;
- And save their loan application for a different future investment.
We also know that vendor financing agreements help vendors:
- Obtain sales and new paying customers;
- Establish a regular cash flow;
- Negotiate numerous security options;
- And charge more interest than a bank.
However, if the buyer defaults or the company goes bankrupt, it will have been an expensive investment gone wrong. Specific security options can help vendors turn it around – like putting a competent third party in charge to steer the ship around or going after the director’s assets – but nothing beats preparatory due diligence for everyone involved.