Deferred consideration explained: staged payments and earn-outs when buying a business

Deferred consideration is the part of a business's purchase price that the buyer pays after completion rather than on the day the deal completes. It can be a fixed sum paid in instalments, or contingent consideration whose amount depends on future results, usually called an earn-out. This guide explains how each type works for buyers and sellers, how the payments are protected, how lenders treat them and the main tax points to raise with your adviser. Smart Funding Solutions is a broker, not a lender; we arrange acquisition funding from around £10,000 to £500,000+, with larger facilities available in suitable cases, through our acquisition finance service. Seller loans, where the seller formally lends part of the price back to the buyer, are covered separately in our guide to vendor finance.

01How deferred consideration works

Deferred consideration works by splitting the price into an amount paid at completion and one or more later payments set out in the sale agreement, with the dates, amounts or formulas, and any conditions, agreed before signing.

Suppose a buyer agrees to pay £1,000,000 for a company. Rather than paying it all on completion, the buyer might pay £700,000 at completion and the remaining £300,000 in three annual instalments. The buyer owns the business from completion; the seller simply waits for part of the money. The obligation to pay sits in the share or asset purchase agreement, and the seller relies on that contract, and any security negotiated, to be paid.

Deferral is common in UK deals of all sizes, from small owner-managed companies to professional practices and management buyouts. It reduces the cash a buyer needs at completion, bridges disagreements on value, and keeps the seller interested in a smooth handover.

02The main types of deferred consideration

There are four common forms, and many deals combine two or more. The table compares them.

Type	How the amount is set	Main benefit	Main risk
Fixed deferred consideration	Agreed sums on agreed dates	Certainty for both sides	Seller depends on the buyer's ability to pay
Earn-out (contingent consideration)	A formula linked to future revenue, profit or another target	Bridges a gap on value; buyer pays more only if results justify it	Disputes over the calculation and how the business is run
Retention or escrow	Part of the price held back, often in a solicitor's or escrow account	Ready money for warranty claims or completion adjustments	Funds tied up until the retention period ends
Vendor loan or loan notes	The seller lends part of the price, usually with interest	Formal debt terms and often security	Ranks behind bank debt; see our vendor finance guide

03Earn-outs explained

An earn-out is a form of contingent consideration where part of the price is paid only if the business meets agreed targets after completion, typically measured over one to three years.

Earn-outs are most useful when the buyer and seller disagree about the future. A seller who expects strong growth can be paid for it if it happens, while the buyer avoids paying upfront for results that may not arrive. They are common in businesses whose value depends heavily on the seller's relationships, such as professional services, agencies and technology firms.

The weakness of an earn-out is that, once the buyer controls the business, the buyer's decisions affect the result. A seller will worry about the buyer loading costs into the business, moving clients to another group company or changing pricing. A buyer will worry about a seller who chases short-term revenue at the expense of margin. Good drafting addresses both concerns.

Earn-out checklist

• The measure. Revenue is simpler to verify; profit is more meaningful but easier to influence. Define exactly what counts.
• The accounting basis. Which policies apply, how group charges are treated and who prepares the figures.
• The period and payment dates. When each period ends and how soon after it payment is due.
• Caps, floors and sliding scales. Whether there is a maximum payment and whether partial achievement earns a partial payment.
• Conduct of the business. What the buyer may and may not do during the earn-out period.
• Information rights. The seller's right to see management accounts and check the calculation.
• Disputes. Referral to an independent accountant acting as expert, rather than court.
• Acceleration. Whether the earn-out becomes payable early if the buyer sells the business or breaches key terms.

04Deferred consideration from the buyer's side

For a buyer, deferred consideration reduces the cash and borrowing needed at completion and provides protection if problems emerge after the sale.

• Lower day-one funding. Less cash at completion means a smaller loan or a smaller personal contribution. Our guide to the deposit needed to buy a business explains how the buyer's contribution fits in.
• Set-off against claims. Sale agreements often let the buyer deduct valid warranty or indemnity claims from deferred payments, which is far easier than chasing a seller who has already been paid.
• Seller commitment. A seller waiting for money has a reason to help with the handover.

The cost is a future obligation that competes with every other demand on cash flow. Buyers should model the deferred payments alongside loan repayments and working capital in a pessimistic forecast, not just the plan. Sellers may also ask for a higher headline price in exchange for waiting.

Earn-outs are most useful when the buyer and seller disagree about the future.

05Deferred consideration from the seller's side

For a seller, accepting deferred consideration can achieve a higher price or a sale that would not otherwise happen, but it means taking credit risk on the buyer and, with an earn-out, on the business's future performance.

Sellers commonly look for some of the following protections:

• a guarantee from the buyer's parent company or from the individual buyers
• security over the shares sold or the business's assets, usually ranking behind the senior lender
• part of the price held in escrow
• restrictions on the buyer paying dividends, selling assets or taking on further debt while payments are outstanding
• the right to be paid in full immediately if the buyer defaults or sells the business

£137,500A transaction we arranged£137.5K to fund an accountancy practice acquisition.An established firm had an acquisition agreed. We structured the funding around the transaction and got it completed.

06How lenders treat deferred consideration

Acquisition lenders generally welcome deferred consideration because it reduces the amount they need to lend and shows the seller's confidence, but they insist that it ranks behind their debt and that payments are only made when the business can afford them.

• Subordination. The seller signs a deed of priority, subordination agreement or intercreditor agreement confirming that the lender is repaid first and that any seller security ranks second.
• Payment conditions. Deferred payments can usually be made only if there is no default on the loan and covenants are met. If they are not, payments are blocked until the position recovers.
• Affordability. Lenders include deferred payments in their cash flow analysis and debt service cover, even though the debt is subordinated. An earn-out is usually modelled at its maximum, or at the level the forecast implies.
• Restrictions on enforcement. The seller usually cannot take action against the business for unpaid sums without the lender's consent, often for an agreed standstill period.

Sellers should understand these terms before agreeing them, because they change the practical value of any security. Buyers should agree payment dates that match the lender's expectations, so they are not caught between two sets of obligations. When deferred payments become difficult to meet from cash flow, some buyers later replace them with new borrowing; see our page on refinancing after an acquisition.

07Tax points to raise with your adviser

The tax treatment of deferred consideration differs between fixed and contingent payments and can be complex, so both buyer and seller should take advice from an accountant or tax adviser before agreeing the structure. The points below are general and are not tax advice.

• Timing for the seller. For a fixed, known amount of deferred consideration, capital gains tax is generally calculated on the full price at the time of the sale, even though some of the money arrives later. In some circumstances, where the price is paid in instalments over a longer period, HMRC may allow the tax to be paid in instalments.
• Earn-outs. Where the amount is unknown at completion, the right to receive future payments is generally valued and taxed at completion, with later payments potentially giving rise to further gains or losses. The rules differ again if the earn-out is satisfied in shares or loan notes.
• Employment-related payments. If an earn-out depends on the seller continuing to work in the business, there is a risk that HMRC treats it as employment income rather than sale proceeds.
• Reliefs. Eligibility for reliefs on the seller's gain, and how they apply to deferred elements, should be checked before signing.

The gov.uk guidance on capital gains tax is a starting point, but the detail of a sale needs professional advice.

08Agreeing deferred consideration in the heads of terms

The structure of deferred consideration should be settled in the heads of terms, before lawyers start drafting, because it affects the funding requirement, the security package and the seller's tax position.

At a minimum, record the amount or formula, the payment dates, any conditions, whether payments can be set off against claims and the expected ranking behind the buyer's lender. Our guide to heads of terms when buying a business includes a full checklist, and our step-by-step guide on how to buy a business shows where this sits in the wider process.

09How Smart Funding Solutions can help