Closing the Gap is our five-part series from John Barton on the structures that bridge the distance between a seller’s view of value and a buyer’s price: where each fits, where each breaks, and the one thing to get right before you sign.
Earlier in this series
- Part 1 – Why the Gap Is About Risk, Not Value
- Part 2 – Why Earn-Outs Break Down and What Protects Your Payment
The price is agreed, and nothing depends on performance. You have lent the buyer the last slice of it, and everything turns on whether they can pay you back.
Vendor Loans – In Brief
A vendor loan leaves part of the consideration with the buyer, repaid with interest over two to five years under a loan agreement.
- What risk are you taking? Not performance risk. Credit risk. You have stopped being an owner and become a lender, to a borrower whose only real asset is the business you just sold them.
- What decides whether you are paid? Where you rank against the bank, what secures the loan, and whether the business can service your repayments and the bank’s out of the same cash flow. All three are settled before signing.
- What do sellers miss? The tax timing. Capital gains tax is triggered when the contract is signed, not when the money arrives, and the bill usually falls due more than a year later. Signing on 1 July rather than 30 June can move it a further twelve months.
No targets, no performance test, nothing to argue about at year end. Where the earn-out asks you to prove the future, vendor loans ask you to wait for it.
Sellers warm to it quickly. The amount is certain. Being paid is not.
The risk you are actually taking
Three questions come first.
Where do you rank? If a bank funded the rest of the price, you sit behind it, and the subordination deed will say so in language most sellers read once. It stops the buyer paying you while the bank’s covenants are stressed, and stops you enforcing while the standstill runs. Your loan can be current, undisputed and unpayable at the same time.
What secures it? An unsecured promise from a company that owns nothing but the shares is not security. A charge over the assets, a mortgage over the shares, a guarantee from someone with something to lose: those are. Each is cheap before signing and unobtainable after.
Who services it? If the buyer geared the business to buy it, your repayments and the bank’s come out of the same cash flow. A soft trading year that once cost you one bad result now runs the term of your loan.
Then set-off. Most first drafts let the buyer deduct warranty claims from the balance, which turns your loan into an open-ended holdback. Cap it, carve it out, or price it.
When the tax actually falls due
Capital gains tax is triggered when you sign the contract, not when the money arrives, and on the whole of the price including the part still sitting with the buyer.
The gain falls into the income year the contract is signed, and that year’s assessment is not payable until well after it ends. Sign on 30 June and the gain lands in the year closing that day, with the bill typically payable around June the following year. Sign one day later and it falls into the next income year, payable around June the year after. One day, and the liability moves twelve months.
Which is worth knowing before you agree a completion date. Later is not automatically better: it turns on your other income in each of those years, and on what else changes between the two dates.
It also changes how you build the vendor loan. If repayments start in the first year and run monthly, a good part of the tax bill can be funded by money the buyer has already paid you. If the loan sits idle until a balloon in year five, you fund the whole liability out of completion cash while the buyer holds the rest.
Set the completion date and the repayment schedule together, with your accountant across both.
Where vendor loans fit
They do their best work where the buyer is credible but short of the last slice of funding: a management buyout, a trade buyer whose bank will only go so far. Often the loan is the only thing standing between a fair price and no deal.
They work poorly as cover for a buyer you doubt. If you would not lend this person the money in any other setting, do not lend it to them because they are buying your business.
Next in the series: the retained stake, where you keep a slice of the equity and are paid out of the buyer’s success.
The information on this website is general in nature and is not intended to constitute financial, legal, or tax advice. It does not take into account your objectives, financial situation, or needs. You should seek appropriate professional advice before acting on any content. While we draw on our experience as business owners and corporate advisors, our insights are not a substitute for tailored advice.
