Vendor Loan Note
A vendor loan note is part of the purchase price that the seller agrees to be paid later, as a loan from the seller to the buyer, with interest, ranking behind the buyer's bank debt. It bridges a gap between what the buyer can fund and what the seller wants, keeps the seller invested in the business's ability to pay, and is the usual way a founder's exit is financed when the bank will not lend the whole price.
- Also known as
- Vendor note, Seller note, Vendor financing, Deferred consideration note
- Used at
- management buy-outs and private equity deals where senior debt and equity fall short; founder sales to smaller buyers; deals where the seller's confidence in the business is worth more to the buyer than cash
- Binding
- yes — a loan note instrument setting the amount, the interest, the repayment date and the ranking, usually with an intercreditor agreement that subordinates it to the banks
- Typical size
- 10–30% of the price; typical interest: 5–10% a year, often rolled up rather than paid in cash; typical term: three to seven years, or on the buyer's exit
- Typical ranking
- behind senior and mezzanine debt, ahead of equity — the seller is paid only if the lenders are, and before the sponsor makes its return
- Parties
- the seller (now a creditor), the buyer, the senior lenders who dictate the subordination, and the sponsor whose equity ranks below
How a vendor loan note works in practice
A buyer offers €40m for a founder's company: €25m of bank debt, €10m of the fund's equity, and €5m it asks the founder to leave in as a loan note. The founder receives €35m at completion and a note for €5m, paying 8% rolled up, repayable in five years or when the buyer sells the company, whichever is first. The note is subordinated: if the company struggles, the bank is repaid first and the founder waits; if it fails, the founder's €5m is likely lost. In exchange the founder has closed a deal that would not otherwise have funded, and holds a claim that pays €7.3m at maturity if all goes well.
Sellers accept the note when the alternative is a lower price or no deal, and negotiate its protections: a fixed maturity rather than "on exit", so the buyer cannot defer it indefinitely; interest paid in cash if the senior lenders allow; security, if the banks will permit any; and events of default — non-payment, a sale of the business, a change of control of the buyer — that make it repayable. Buyers use the note as a signal: a seller who refuses any deferred element is telling the buyer something about the forecast.
Unlike an earn-out, the note is not contingent on performance — it is a debt, owed whatever the business does — but it is contingent on solvency, which is the same risk in a different form.
Example
A founder sells a lending software company for £24m: £18m in cash at completion and a £6m vendor loan note at 7% rolled up, repayable in four years, subordinated to £12m of senior debt. The buyer's plan is to sell the business in year four. In year two the business misses its plan and the bank's covenants are reset; the intercreditor agreement blocks any payment on the note while the senior debt is in default, and the note's maturity is extended to year six as part of the restructuring. The business recovers and is sold in year five for £45m: the bank takes its £9m remaining, the founder's note is repaid at £8.4m with the rolled-up interest, and the fund's equity takes the rest. The founder received £26.4m in all — more than the £24m headline — but two years later than agreed, and would have received £18m had the recovery not come.
Common mistakes
- Accepting a note repayable "on exit" with no long-stop date. - Not reading the intercreditor agreement, which decides when the note can actually be paid. - Interest rolled up and taxed as it accrues, in some jurisdictions, before any cash arrives. - Buyers offering a note to close a price gap without telling the senior lender, who must consent to it. - Sellers treating the note as cash in their own planning; it is a subordinated loan to a leveraged company.