What is Vendor Financing

Vendor financing is the lending of money by a vendor to a customer who then uses it to buy the vendor's inventory or services. Sometimes called "trade credit," such financing usually takes the form of deferred loans from the vendor. It may also include a transfer of shares of the borrowing company to the vendor. Vendor financing is most common when a vendor sees a higher value in a customer's business and business relationship than a traditional lending institution does. Such loans carry a higher interest rate than what a borrower would normally find at a bank.

BREAKING DOWN Vendor Financing

Vendor financing helps business owners purchase essential goods or services without having to approach banks or dip into personal funds as collateral. The use of vendor financing serves to establish a credit history and also preserves bank financing for when it is really important, such as for capital improvements that will boost revenue.

Key to vendor financing is an established relationship between the borrower and the vendor. While not receiving cash for a sale once it is agreed upon might be less than ideal, it can be better than not making a sale at all. In the meantime, the vendor can sometimes earn interest on their financing, though vendor financing can also equate to a deferred payment without interest. Offering vendor financing can amount to a competitive advantage for sellers of big-ticket items. Such use of credit in vendor finance is called an "open account."

Vendors can take many forms. For example, they can be service providers such as payroll management companies, security or maintenance companies. Business-to-business suppliers, such as a building supply warehouse for a builder or an office supply company, are common providers of vendor financing, as are manufacturers of equipment or material and parts suppliers.

Vendor Financing Types

Vendor financing can be accomplished using both debt and equity. In debt vendor financing, the borrower agrees to pay a price for inventory with an agreed-upon interest charge. The sum is either repaid over time or written off as a bad debt. In equity vendor financing, the vendor can provide goods in exchange for an agreed-upon amount of company stock. Equity vendor financing is more common with startup businesses, which often use a form of vendor-supplied financing called "inventory financing," which essentially uses inventory as collateral to back a line of credit or short-term loan.

Vendor financing can also be used when an individual does not have enough money to buy a business outright. A vendor may consider the business in question, as well as its sales, as essential to its own financial targets and provide financing in the form of a loan with an interest charge to help the business buyer close the sale.