Vendor finance and deferred consideration when buying a business

This guide is for buyers putting together the funding for an acquisition and for owners deciding how much of their price they are prepared to wait for. In smaller UK deals, a seller who takes some of the price later is often what turns an unfundable purchase into a fundable one. Smart Funding Solutions is a broker, not a lender: we arrange the bank and specialist debt that usually sits alongside vendor finance, approaching lenders on our panel of 300+ for facilities from around £10,000 to £500,000+, with larger facilities available in suitable cases. The wider picture of deal funding is in our acquisition finance guide.

01What vendor finance means in an acquisition

The seller of a company or business agrees that not all of the price will be paid at completion. The unpaid part becomes an obligation of the buyer, paid later on agreed terms. The seller is, in effect, a lender to the buyer, although usually one who ranks behind the bank.

The phrase is also used for something different: an equipment manufacturer or dealer arranging finance for its customers at the point of sale. That is a form of asset finance, not the subject of this guide.

02The three main structures

Structure	How it works	Suits	Main tension
Fixed deferred consideration	Set amounts paid on set dates after completion	Stable businesses where price is agreed and only timing is the issue	An unconditional debt the buyer must pay even in a bad year
Earn-out	Further payments depend on future turnover, gross profit or earnings	Growing or volatile businesses where buyer and seller disagree on value	Arguments over how results are measured and who controls them
Vendor loan note	A formal debt instrument issued to the seller, usually carrying interest and a repayment date	Larger or more formal deals, often alongside bank and investor funding	Interest cost and the seller's demands for security

A fourth arrangement, the retention, is related but different: part of the price is held back, often in a solicitor's client account or escrow, to meet any warranty claims, then released to the seller after an agreed period. It protects the buyer rather than helping to fund the deal.

03Why buyers and sellers agree to it

For the buyer

• Less cash and bank borrowing needed on the day.
• A seller with money still riding on the business has a reason to support the handover and introduce customers.
• Deferred payments give the buyer a fund to set warranty claims against, if the agreement allows set-off.
• An earn-out lets the buyer pay a higher headline price only if the promised growth appears.

For the seller

• A wider pool of buyers, including management teams and first-time buyers who could not raise the whole price.
• Potentially a higher total price than a buyer would pay in cash on completion.
• Interest on a loan note can add to the return.

The seller's side of the bargain is risk. If the business fails under new ownership, deferred payments may never arrive, and a seller ranking behind the bank is likely to recover little.

04Which deals suit vendor finance?

Vendor finance works best where a profitable business with steady cash flow is being sold by an owner who trusts the buyer and does not need every pound on completion. Typical examples are retiring owners selling to a management team, outside buyers with relevant sector experience, employee ownership trust sales and client-based professional practices. Senior lenders still expect the buyer to put in their own money, so a buyer with no cash of their own is rarely rescued by deferral alone; our guide to the deposit needed to buy a business explains why. It suits less well where the business is loss-making, the seller has debts that must be cleared at completion, or buyer and seller already disagree on value.

05How senior lenders assess vendor finance

Banks and specialist acquisition lenders welcome vendor finance because it shows the seller believes in the business and reduces the amount they have to lend. They also treat it with caution, because every pound paid to the seller is a pound not available to repay them.

• Affordability. Fixed deferred payments and loan note interest are included when the lender tests whether cash flow covers all commitments. An earn-out may be modelled on the expected outcome.
• Subordination. The lender will normally require the seller to sign a deed of priority or intercreditor agreement. Its effect is that the seller's claim ranks behind the lender's, and that deferred payments stop if the borrower breaches its loan terms.
• Permitted payments. Loan documents often allow payments to the seller only if the borrower is up to date and within its covenants at the time.
• Quasi-equity. Where the seller's money is fully subordinated and only paid from surplus cash, some lenders view it almost like equity, which can support a larger senior loan.

Lenders differ widely in how generous they are here, which is one reason to compare several. Our guide to comparing business acquisition lenders sets out what to weigh besides price.

06Illustration: a £1.2 million purchase

Illustration. A made-up deal with deliberately simple figures. A buyer agrees to acquire a regional facilities maintenance company for up to £1,200,000.

Element	Amount	When paid
Buyer's own cash	£300,000	Completion
Senior term loan	£500,000	Completion
Fixed deferred consideration	£250,000	Three annual instalments
Earn-out	Up to £150,000	After year two, only if gross profit exceeds an agreed level

The seller receives £800,000 on completion and could receive up to a further £400,000. The lender will test whether the combined business can meet its loan repayments and the fixed instalments in a cautious year. If it can only do so in a strong year, the parties may move more of the price into the earn-out, lengthen the deferral or reduce the price.

Banks and specialist acquisition lenders welcome vendor finance because it shows the seller believes in the business and reduces the amount they have to lend.

07Security for vendor finance: protecting the seller

Vendor finance is usually secured, if at all, by a charge over the buyer's shares in the target or a second-ranking charge over its assets, often backed by a guarantee, and always behind the senior lender's security.

A seller being asked to defer a significant sum should negotiate protection, bearing in mind that the bank's requirements come first:

• A charge over the buyer's shares in the target, or a second-ranking charge over its assets. Charges granted by a company must be registered with Companies House within the statutory period; GOV.UK explains how to register a charge for a limited company. Our guide to debentures and fixed and floating charges explains how ranking works.
• A guarantee from the buyer's parent company or its directors.
• Acceleration: the whole balance becomes due if the buyer defaults, sells the business or goes into insolvency.
• Information rights: regular management accounts so problems are visible early.
• Restrictions on the buyer stripping cash out through dividends or management charges while instalments are outstanding.

£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.

08Designing an earn-out that does not end in a dispute

Earn-outs cause more post-completion arguments than any other part of a sale. The recurring problems are predictable, so address them in the agreement:

• Define the measure precisely, including accounting policies, treatment of group recharges and one-off costs.
• Agree what the buyer may and may not do during the earn-out period, such as merging the business into another division.
• Choose a measure the seller can influence if they are staying on, and one that cannot be easily manipulated if they are not.
• Cap the total and set a clear payment date.
• Include an expert determination process for disagreements over the figures.

09Tax points for the seller

The tax treatment differs between the structures. Broadly, a fixed deferred amount is usually treated as part of the price at the date of sale, even though it has not been received. An earn-out whose amount cannot be known at completion is treated differently: HMRC's capital gains manual on earn-out rights explains the approach. Loan notes can have different consequences again, including for reliefs such as Business Asset Disposal Relief. Sellers should take specialist advice before agreeing the mix, because the structure can change both the tax and when it falls due.

10Professional practice sales

Deferred consideration is especially common in the sale of accountancy, financial planning and similar client-based practices, where part of the price is often linked to how many clients remain after a year or two. Our page on block of fees finance covers how retention-linked prices are funded.

11Alternatives when the seller will not wait

• Mezzanine debt can bridge the gap between senior debt and the buyer's cash, at a higher cost. See mezzanine finance.
• Investor equity fills the gap in exchange for a share of ownership.
• Asset-based lending against the target's debtors, stock or plant can increase the upfront funding.
• A lower price or a smaller stake may be the honest answer if the numbers do not work.

Vendor finance plays a particular role in management buy-ins, where an outside team needs the seller's confidence, and in employee ownership trust sales, where most of the price is usually deferred.

12How long vendor finance takes to agree and repay

Vendor finance is negotiated as part of the sale, so it rarely changes the overall timetable by much: most small and medium-sized acquisitions typically take a few months from heads of terms to completion, driven by due diligence and the senior lender's approval. The step that most often adds weeks is the deed of priority, because the seller's and lender's solicitors must agree when deferred payments may be made and when they must stop. Agreeing those points in the heads of terms saves time later. Once the deal completes, deferred consideration is commonly paid over one to three years, with loan notes and employee ownership trust sales sometimes running longer.

13Documents a senior lender will review

Where part of the price is deferred, the senior lender reads the seller's paperwork as closely as its own:

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