What Does Vendor Financing Mean?
Vendor financing is when a vendor lends money to borrowers to buy the products sold by said vendor. This type of financing helps the vendor company increase sales, though it can be risky at times. Typically, most vendor financing is in the form of deferred payment and it can come with or without interest, depending on the terms that are most favorable to the vendor.
Divestopedia Explains Vendor Financing
Vendor financing is extensively used in private equity and was especially used after the Great Recession when cash flows were low due to tight credit markets. To alleviate this problem, many private equity companies began to finance their own buyout to ease financing for the buyer. These private equity firms would give a loan to the buyer from their own books so that the amount of money the borrower had to arrange was reduced. At the same time, it also reduced the leverage ratios.
This arrangement is beneficial to both the vendor and the borrower. From a private equity firm's perspective, a particular asset has to be bought by someone so that it can return money back to its investors. If there are no buyers then the pressure from investors increases and this can cause financial turmoil for the equity firm. Hence, it is a sensible move to finance its own buyout so that it can continue to maintain its investor base and reputation.
From a borrower's perspective, this form of vendor financing is beneficial. Firstly, the borrower is saved of the hassle to arrange funds needed to buy the assets from the vendor. It is much easier for the borrower when the financing comes from the vendor company. Secondly, most vendor financing loans are deferred payments; therefore, the borrower does not have to pay interest on the loan. This is a big advantage because if the borrower takes a loan from the bank then interest has to be paid in addition to the principal. In this case, the interest is a savings for the borrower.