Businesses which have exhausted normal methods of acquiring capital may find themselves turning to less known methods, such as vendor financing. Like the majority of types of alternative financing, it’s less a broad solution and much more a specific help for small businesses whose needs fall into a specific niche.
Is it the best choice for the particular small company financing needs? Read on to find out.
What Is Vendor Financing?
Vendor financing, sometimes called “seller financing” or “trade credit”, is a financial practice in which the vendor selling a product or service also finances it. Businesses with vendor financing in hand won’t need to approach a 3rd party lender, just like a bank, to get financing.
Since the seller is taking on substantial risk within this type of arrangement, vendor financing is usually only a choice for companies that have a strong working relationship using the vendor, although there are exceptions.
How Vendor Financing Works
In a means, vendor financing harkens to the barter system, with two businesses creating a trade.
Vendor financing typically takes one of three forms, which I’ll go into within the next section. Either way, the vendor will help you to acquire their goods or services in exchange for:
- A promise of repayment
- Equity in your company
- Credit with which to get your goods or services.
Depending on the arrangement you agree to, the financing might not cover the entirety from the purchase. If so, you’ll be asked to create a deposit.
Types Of Vendor Financing
The term “vendor financing” encompasses a number of different arrangements a vendor can make having a small company. The three most typical are:
Debt Financing
If your vendor is extending debt financing, they’re essentially proclaiming to offer you financing. But instead of receiving a lump sum of money, you’ll receive the goods or services decided. In many cases, the seller will only finance a percentage from the cost of their item, meaning you’ll have to create a down payment of some type.
From here, debt financing looks a lot like financing. You’ll exercise a payment schedule together with your vendor, as well as an interest rate–if your vendor really wants to make the sale badly enough, there might not be one, but don’t count on it–and set up any collateral necessary. If you’re acquiring a tangible item, debt financing might resemble a tool loan, using the item serving as collateral.
Whether or otherwise this is an excellent deal for your business will depend on the terms agreed upon, particularly in comparison to the loans you might qualify for. Mature businesses searching for vendor financing will probably prefer debt financing to equity financing because it has fewer long-term repercussions in your operations.
Equity Financing
Vendor financing doesn’t necessarily involve dealing with debt. In some instances, a vendor offer your services or goods in return for a share of equity in your company. The seller then turns into a shareholder, receiving dividends and taking part in your business decisions.
In many instances, a business that agrees to equity financing is a startup that doesn’t have the credit or history to be eligible for a other types of financing. Since you’re involving outside entities inside your business operations, you’ll have to factor that into your strategic business plans and risk assessments.
Service Swap
In less common cases, a vendor may be prepared to trade their product for just one of your own of similar value. These types of agreements are much more prone to be informal and between companies that already have a strong working relationship.
Vendor Financing Pros & Cons
So what are the pro and cons of using vendor financing?
Pros:
- You Can Bypass Financial Institutions Entirely: If you don’t match the profile of a good borrower, it can be hard to obtain the money you have to buy inventory, equipment, or vital services. Vendor financing allows you to plead your case directly to the organization you’d be spending your money with.
- Startups Can Get Important Items: Startup financing is among the great hurdles when you’re starting a company. Without a business history, lenders may not wish to have a risk you. Equity financing gets around this Catch-22.
- It Helps Vendors Make Sales: While “giving away” a product with an IOU may carry some risk, a deferred payment still allows a company to maneuver inventory it might not otherwise happen to be able to.
Cons:
- You’re Restricted to Exactly what the Vendor Sells: Vendor financing is just proficient at the organization that you’re petitioning. Having a capital loan, for instance, you can split your lump sum payment between multiple expenses.
- It’s Not That Common: If you’re counting on vendor financing, you’ll likely end up constrained when it comes to the selection of vendors.
- It Exposes Both The Vendor & Buyer To Risk: Neither company is a bank. Vendor financing adds complexity as to the would otherwise be a pretty simple retail transaction. The vendor needs to have a plan for if the buyer defaults. The customer must read the small print and make sure they've recourse under state law if they’re not able to match the the agreement.
When To Use Vendor Financing
If you’re considering debt financing, it’s probably because you have a strong working relationship using the vendor in question. Trust is the name of the game here, so as being a reliable, valued customer will be handy. Whether or not it’s a great deal relative to a similar loan is determined by the terms you’re offered, though it’s fairly simple that you can end up being economical than you would servicing a conventional loan.
When you are looking at equity financing, you’re looking at a far more specific niche. Startups willing to spend a few of their equity to acquire necessary equipment might find it easier to cope with than taking on credit card debt.
Finally, any two businesses that are comfy with the arrangement may be pleased to swap services.
Final Ideas on Vendor Financing
Vendor financing is really a quirky but legitimate way to get your business the inventory, equipment, or services it requires, if you approach the matter having a clear idea about its perks and downsides.
For other ways to get vendors to finance their own products, you might want to read up on captive lessors.
Looking for forms of financing that don’t involve taking out a loan? Read The Merchant’s Help guide to Invoice Factoring. Have a startup and want financing, but aren’t sure you want to give up equity right now? Find out how to Get The gear You'll need For the Startup Business With A Loan Or Lease.
