Deal process
What Is a Vendor Loan Note in a UK Business Acquisition?
A vendor loan note is part of the price the seller lends back to the buyer. How it works, how it sits beside bank debt, and what to agree before you sign.
Short answer
A vendor loan note is part of the price the seller lends back to the buyer. How it works, how it sits beside bank debt, and what to agree before you sign.
Key takeaways
- A vendor loan note is a debt the buyer owes the seller: part of the purchase price is not paid at completion but lent back and repaid over an agreed term, usually with interest.
- Unlike an earn-out, it is not contingent on performance — the amount is fixed, and the risk the seller carries is whether the business can pay it, not whether it hits a target.
- Where there is bank debt, the note is almost always subordinated: the lender is repaid first, and the seller may have to wait if cash is tight.
- The terms that matter most are the amount, interest, repayment schedule, ranking against senior debt, security, and what counts as default.
- A buyer should model the note as a real cash obligation in every year it falls due, because it competes with debt service for the same cash.
What a vendor loan note is
A vendor loan note — also called seller financing or deferred consideration on loan terms — is the part of the purchase price a seller agrees to receive later, as a loan to the buyer. If a business is bought for £2m, the buyer might pay £1.4m in cash at completion and issue a £600k loan note to the seller, repayable over three to five years. The seller has sold the business; they have also become one of its creditors.
It is common in owner-managed business sales in the UK because it solves a practical problem: banks and asset-based lenders will rarely fund the whole price of a smaller company, and a buyer often cannot cover the gap with equity alone. The seller lending part of the price back is frequently what makes the deal fundable at all.
Why buyers and sellers agree to one
For the buyer, a loan note reduces the cash needed on day one and spreads the cost of the acquisition over the years the business itself generates the cash to pay for it. It also signals something: a seller willing to be paid later from the business's own earnings is a seller who believes the earnings are real.
For the seller, it can be the difference between a sale and no sale, or between a sale at the price they want and a lower all-cash offer. Interest on the note adds to what they receive overall. The trade-off is risk: if the business struggles after completion, the seller may wait longer to be paid, or not be paid in full.
The terms that decide how a loan note behaves
| Term | What it decides | What to watch |
|---|---|---|
| Principal | How much of the price is deferred | Whether the lender has a view on the ratio of note to senior debt |
| Interest | What the seller earns for waiting | Whether it is paid in cash each year or rolled up and paid at the end |
| Repayment schedule | When instalments fall due | A schedule that bunches payments into years when bank debt is also high |
| Ranking | Whether the seller is paid before or after the bank | Senior lenders will usually require the note to be subordinated |
| Security | What the seller can claim if the buyer defaults | A second charge behind the lender, or a personal guarantee |
| Default and acceleration | What happens if a payment is missed | Whether the seller can demand the whole balance, and whether the lender lets them |
How a loan note sits beside bank debt
Where a deal has senior bank debt, the lender will usually insist on an intercreditor or subordination agreement. That agreement sets out that the bank is serviced first, and that the seller's repayments can be paused if paying them would breach the bank's covenants. In practice this means a seller's repayment can be deferred and accrued rather than paid in a difficult year, with the seller unable to enforce while the bank is still owed.
A buyer should read this carefully in both directions. Subordination protects the business from a seller demanding payment at the wrong moment, but it does not make the obligation go away — a deferred instalment is still owed, with interest, and lands in a later year.
Loan note vs earn-out vs deferred consideration
| Structure | Depends on performance? | Typical purpose |
|---|---|---|
| Vendor loan note | No — a fixed debt with interest and a schedule | Closing a funding gap the bank and buyer equity cannot cover |
| Earn-out | Yes — paid only if targets are met | Bridging a disagreement over what the business is worth |
| Deferred consideration | No — a fixed sum on a fixed date, often without interest | Spreading the buyer's cash outlay without a formal loan |
Many deals combine them: cash at completion, a loan note, and an earn-out on top. Each should be named separately in the heads of terms, because mixing them up — treating a contingent payment as a fixed debt, or the reverse — causes real disagreement when the sale and purchase agreement is drafted.
Tax points to raise with an adviser
How a loan note is taxed for the seller depends on how it is structured, and can affect when capital gains tax is due and whether reliefs such as Business Asset Disposal Relief apply to the deferred element. This is an area where the drafting changes the outcome, so both sides should take tax advice on the specific structure rather than assuming it follows the cash at completion.
Common mistakes
- Treating the note as free money. It is a cash obligation in every year an instalment falls due, and it competes with bank repayments for the same cash.
- Agreeing the amount before the lender has seen it. A senior lender may cap the note, require it to be subordinated, or change its own terms because of it.
- Leaving default vague. If the agreement does not say what happens when a payment is missed, the first difficult year becomes a dispute.
- Ignoring interest roll-up. Interest that accrues rather than being paid makes the final balance larger than the headline figure.
Negotiating a loan note in practice
Most negotiation over a loan note happens late, once the buyer knows what the bank will lend. A buyer who has a term sheet from a lender can show the seller exactly where the gap is and why the note is the size it is, which tends to make the conversation about structure rather than about trust. A seller who is asked for a note with no funding evidence behind it is right to ask why.
Sellers commonly ask for something in return for waiting: a higher interest rate, a shorter term, a personal guarantee from the buyer, or a step-up in the amount if repayments are paused. Buyers commonly ask for the flexibility to repay early without penalty, so the note can be cleared if the business refinances. Both are reasonable, and both need to be agreed with the senior lender in mind, because the lender will read the note before it signs its own facility.
How TrueValue models a vendor loan note
In TrueValue's deal economics, a vendor note is its own line in the consideration structure, with its amount and whether it is subordinated. A subordinated note is serviced after senior debt, and where the debt service cover covenant would be breached its payment is deferred and accrued rather than treated as a default — and the deferral is reported, so it is visible rather than hidden in the totals. Fixed-charge cover tests the year's cash against every obligation it creates, including vendor payments, so a structure that passes the bank's covenant but cannot pay the seller shows up before the offer goes out.
Frequently asked questions
What is a vendor loan note in simple terms?
- It is part of the purchase price that the seller lends back to the buyer instead of receiving it at completion. The buyer repays it over an agreed period, usually with interest, out of the business's cash.
Is a vendor loan note the same as an earn-out?
- No. A loan note is a fixed debt that is owed whatever the business does. An earn-out is only paid if agreed performance targets are met, so it can pay more, less or nothing.
Does the bank get paid before the seller?
- Usually yes. Where there is senior bank debt, the lender will normally require the loan note to be subordinated, so the bank is serviced first and the seller's payments can be paused if paying them would breach the bank's covenants.
What happens if the buyer cannot repay the loan note?
- That depends on the agreement. It should say what counts as default, whether the seller can demand the whole balance, what security they hold, and how any intercreditor agreement with the bank limits what they can do while the bank is owed.
Should a seller accept a vendor loan note?
- It can make a sale possible or achieve a higher price, but it means the seller carries risk on the business after they have left. A seller should look at the ranking, security and default terms as carefully as the headline amount, and take legal and tax advice.
Can TrueValue model a vendor loan note?
- Yes. The deal economics engine treats a vendor note as a line in the consideration structure, services a subordinated note after senior debt, defers and reports payments where the cover covenant would be breached, and includes vendor payments in fixed-charge cover.
Put this to work in TrueValue
Related guides
- What Is an Earn-Out in a Business Acquisition?
An earn-out pays the seller more if the business hits agreed targets after completion, and less — or nothing — if it does not. It bridges a price gap, but it also creates a relationship that runs past the day the deal closes.
- How to Structure a Business Acquisition
The price is one number. The structure is everything else: how that number is actually paid, what legal form the deal takes, how it is funded, and who carries the risk if something turns out to be wrong. Get the structure wrong and the price stops meaning what it said.
- Heads of Terms in a UK Business Acquisition
Heads of terms are the short document that records the agreed deal before diligence and drafting begin. Mostly not binding, they still shape everything that follows — so what they say, and what they leave out, matters.
- Locked Box vs Completion Accounts: How UK Buyers Fix the Final Price
The two ways to turn a headline offer into the price that actually changes hands, where each goes wrong, and how buyers choose between them.
- How to Calculate IRR and MoIC on a Business Acquisition
IRR and MoIC answer different questions about the same deal — one is a rate, the other a multiple — and a structure that improves one can leave the other unchanged or worse. Here is how each is actually calculated, with a worked example on a debt-funded SME acquisition.