Vendor and seller finance, and whether your lender counts it as equity

What vendor finance is

Vendor or seller finance is part of the purchase price left outstanding by the seller and paid after completion. No third party lends anything. The seller waits.

It comes in three forms that get used interchangeably in conversation and are quite different in a contract.

• Deferred consideration. A fixed amount, paid on agreed dates. Certain, and simply later.
• An earn-out. A variable amount, calculated from how the business performs after completion against an agreed formula over an agreed period.
• A loan note. The deferral formalised as a debt instrument, usually carrying interest and with its own terms about repayment and default.

Which one is used changes the seller's tax position, their risk, and how a lender reads the deal. It is a drafting decision with consequences, not a label.

The question that decides how much you can borrow

This is the part worth understanding properly, because it changes the amount of external funding available on day one.

Some lenders will treat properly subordinated vendor deferral as part of the buyer's own stake in the deal, on the basis that it is money at risk behind theirs. Others treat it as debt that competes for the same cash, and size the facility as though it were another loan. The same deal, put to two lenders, can produce a materially different answer for that reason alone.

What separates the two is the drafting. A lender is far more likely to count it in the buyer's favour where the deferral is unsecured, is formally subordinated to the senior facility by deed, carries no right to accelerate or enforce while that facility is outstanding, and is payable only out of cash left after the bank has been paid. Anything that lets the seller jump the queue, or take security, moves it back into the debt column.

How that is drafted in practice, and what a seller can reasonably expect in return, is covered in vendor finance. What a lender expects from the buyer's own pocket alongside it is in equity contribution.

Why lenders like it, when it is done properly

A seller who leaves money in is a seller who still has a financial reason to care whether the business works after they have gone. Nothing else in a transaction sends that signal as clearly, which is why a lender will often lend more against a deal with a deferral in it than against the same business bought entirely for cash.

It also reduces the amount of senior term debt required, which lowers the repayment burden the acquired business has to carry in its first years. And where there is still a shortfall, it is usually cheaper than filling the same space with mezzanine, which is the comparison worth making before anyone reaches for a third lender.

Where it matters most

Deferral is close to standard in sectors where what is being bought is a set of relationships rather than a set of assets. In accountancy practice purchases the money is almost always staged, with a retention tied to fees that actually transfer, because the risk being managed is client attrition and the seller is the only person who can influence it.

The same logic applies wherever a founder holds the customer relationships personally: a maintenance base, a contract book, a set of long-standing commercial clients. The deferral is the mechanism that keeps the seller interested through the handover.

The seller's side of it

A seller taking deferred money is lending to the buyer, usually unsecured and usually behind a bank. That is a real risk and it is reasonable for them to want something for it: interest on the outstanding amount, a shorter payment period, tighter conditions on what the buyer can do with the business while it is outstanding, or a personal guarantee.

Some of those the senior lender will accept and some it will refuse outright, and finding out which at the last minute is how deals stall in the final fortnight. The tax treatment of each form differs as well, and that is a question for the seller's own accountant rather than something to settle across a table.

What goes wrong

The earn-out is measured on something the buyer controls. Profit after the buyer's own management charges, or after a restructuring the buyer chose, is not a fair test and it produces litigation. Agree the metric, the accounting policies and who prepares the figures, in writing, before completion.

The seller has no influence over the period being measured. An earn-out tied to performance the seller cannot affect, because they left at completion, is a dispute with a date on it.

The retention cannot actually bite. Where the deferred money has all been paid by the time attrition shows up, or the seller has nothing left to recover from, the clause is decoration. The measurement period has to outlast the risk.

The subordination deed is left to the last week. It sits between the seller, the buyer and the bank, all three have to agree it, and it is not a formality.

The two sides mean different things by the same words. "Deferred over three years" can describe half a dozen different payment profiles. Write the schedule out.

What a lender will want to see

• Heads of terms stating exactly how much is deferred, over what period and on what conditions.
• The proposed subordination position, and whether the seller is asking for security.
• The earn-out formula in full, with the accounting basis and who calculates it.
• What the seller is doing after completion, and for how long.
• The trading history the deferral is meant to protect against.

Terms that appear in this part of a contract and nowhere else are in the glossary.

Knowing which lenders count it in your favour

There is no public list of which lenders treat a subordinated deferral as part of the buyer's stake and which do not. It is a matter of individual credit policy, it changes, and the only way to know is to have asked recently.

We know this market and we know specific people who fund these deals, so we can tell you whether the deferral you have negotiated will be read as equity or as debt before the structure is fixed. Tell us the shape of the deal and we come back to you having spoken to them.