Vendor loan notes. How the part of the price a seller leaves in funds a buyout.
In short
A borrower-side guide to vendor loan notes in a UK lower-mid-market buyout. A vendor loan note is part of the purchase price the seller agrees to receive later, documented as a loan from the seller to the buying company. It bridges the gap between the price and what prudent debt plus the buyers' own equity can fund. A senior lender funds alongside the notes only if they rank behind it: repayment blocked or confined to an agreed schedule while the senior debt is outstanding, interest usually rolled up rather than paid, no enforcement by the seller without the lender's consent, and a maturity after the senior facility's. The terms worth negotiating are the rate, the maturity, what may be paid in cash and when, set-off for warranty claims, and what happens on a sale or refinancing.
Written by Gregory Elgunov, Managing Director · Last reviewed 27 September 2026
A vendor loan note is the buyer paying part of the purchase price with its own debt instead of cash. The seller accepts a note from the buying company and is paid that part later, usually with interest. In a lower-mid-market buyout it is often the piece that makes the deal work, because the debt a business can prudently carry and the cheque a management team can write rarely add up to the price the seller wants. A senior lender welcomes the notes, but only on terms that keep the seller’s claim behind its own.
Written for the buying side of the table. This is general guidance, not advice on your transaction; the loan note instrument, the sale agreement and the tax structuring belong to your lawyers and accountants. The full stack the notes sit in is set out in our guides to financing a management buyout and financing a management buy-in.
Part of the price, paid later and documented as a loan.
A vendor loan note is a debt instrument issued by the buying company, typically a new holding company formed for the deal, to the seller in satisfaction of part of the price. The instrument sets the principal, the interest rate and whether interest is paid in cash or added to the debt, the repayment date, the events that let the holder demand early repayment, and any limits on transfer. The seller becomes a creditor of the business they have just sold.
Most notes are unsecured, and they are owed by the holding company, not by the trading business whose cash repays them. That ranking is what makes them acceptable to a lender, and it is the seller’s main risk: in a failure the notes come behind the senior debt and behind the trading company’s own creditors, as the figure in section 04 shows, and there may be little or nothing left for the seller. Our library entry on holdco and opco debt sets out why. Loan notes are one form of vendor paper, alongside deferred consideration, and section 06 compares both with an earn-out.
Prudent debt and the team’s cheque rarely reach the price.
The senior debt is sized on what the company’s cash flow can service through a bad year, roughly 2.5 to 3.5 times EBITDA from a bank on a sponsorless buyout, and toward the lower end where the team is new to the business. The managers’ own money is limited by their personal means. Between the two there is commonly a shortfall against the price, and each way of closing it has a cost: more debt than is prudent, an outside equity partner and the control that comes with one, a lower price, or part of the price paid later. The last is the cheapest in cash terms and the least dilutive, which is why almost every lower-mid-market management buyout carries some vendor paper.
The seller gets a price an all-cash offer would not reach, plus interest on the part left in, and an owner selling to their own team may find the notes are what makes the sale possible at all. The buyers keep more of the company and avoid cash going out in the early years. A lender also reads a seller who leaves money in as believing the plan, which counts for more on a buy-in, where the seller knows the business and the buyers do not. How large the team’s own cheque needs to be is worked through, with a calculator, in our guide to how much equity a management buyout needs.
As a claim that waits its turn, written into the intercreditor.
A senior lender funds alongside vendor loan notes only if they cannot take cash or control ahead of it. That is written into an intercreditor agreement or, on a simpler deal, a subordination deed the seller signs before the lender funds. Principal is blocked until the senior debt is repaid, or allowed earlier only under an agreed schedule and tests. Interest is either added to the notes, the PIK treatment, or paid in cash only when no default is continuing and an agreed test is met. The seller cannot demand repayment, sue or petition to wind the company up without the lender’s consent, usually until the senior debt is repaid, and the notes mature after the senior facility.
Who is repaid first, on an illustrative £10m buyout.
Rank 1: Senior debt£6.0m
Secured on the group and guaranteed by the trading company. Repaid first.
Rank 2: The trading company’s other creditors
Suppliers, landlords and HMRC. Owed by the business itself, so ahead of anything owed by the holding company.
Rank 3: Vendor loan notes£2.0m
Owed by the holding company and subordinated by deed. Paid only when the senior lender allows.
Rank 4: Equity£2.0m
The team’s money. Paid last, and takes whatever value is left.
Illustrative: the funding stack from our equity guide’s worked example, before costs, in the simplified order claims are met on an insolvency.
A standstill after which a junior creditor may act is a mezzanine term, and a seller has one only by negotiating for it. Two consequences follow for the buyers. A lender testing whether the company can service its debt counts any cash interest on the notes, so a cash-pay note shrinks the senior facility where a rolled-up one does not. And notes count as debt under a standard leverage covenant definition, so leaving fully subordinated, non-cash-pay notes out of it is a carve-out to agree in the term sheet. The wider question of what cash may leave the group is the permitted payments schedule.
The rate, the maturity, the cash it may take, and what happens on a sale.
The rate is a negotiation. A seller taking subordinated risk can argue for a return above the senior lender’s, while an owner selling to their own team may accept a modest one. Whatever is agreed is usually rolled up, and where the instrument adds the interest to the principal each year it compounds, so model what the notes will have grown to by the time they fall due. The calculator starts from £2m at 8% for five years, an illustration and not a market rate.
What the notes grow to, by interest treatment.
The guide’s example · edit any figure
Due after 5 years if the interest compounds annually
£2,938,656
- If the interest is simple
- £2,800,000
- What compounding adds
- £138,656
- If paid in cash each year
- £160,000 a year
Rolled up, the interest adds £938,656 to what the next refinancing has to cover. Paid in cash, £160,000 a year leaves the business alongside the senior debt service, which is why a lender blocks cash interest or tests it first.
| Year | Notes issued | Rolled-up interest | Total |
|---|---|---|---|
| Issue | £2.0m | £0k | £2.0m |
| Yr 1 | £2.0m | £160k | £2.2m |
| Yr 2 | £2.0m | £333k | £2.3m |
| Yr 3 | £2.0m | £519k | £2.5m |
| Yr 4 | £2.0m | £721k | £2.7m |
| Yr 5 | £2.0m | £939k | £2.9m |
- Notes issued
- Rolled-up interest, compounding
Annual periods, no fees, repaid in one sum at the end. An illustration of the arithmetic, not a quote or a market rate. Calculated in your browser.
The final maturity should fall after the senior facility’s, with the buyers free to repay early, without a premium, whenever the senior lender allows. The usual compromise is a long final date with scheduled early repayments permitted only when the lender’s tests are met. Test that schedule against the downside case, because note payments that coincide with the heaviest senior amortisation compete directly with debt service.
Three protections matter to the buyers. The first is a right to set off warranty and indemnity claims against the notes, which the intercreditor must also permit because it discharges part of the subordinated debt; it matters most on a buy-in, since on a management buyout the warranties are usually limited. The second is a short, objective list of events of default, with an express statement that a payment the intercreditor blocks is postponed, not missed, so the notes cannot trip the senior facility’s cross-default clause. The third is the seller’s undertaking to sign a new subordination deed with any lender that refinances the senior debt, without which the seller can hold up every refinancing. The notes themselves fall due on a sale of the company.
All three are price paid later. They differ in certainty and in form.
Loan notes, deferred consideration and earn-outs, side by side.
| Row | Loan notes | Deferred consideration | Earn-out |
|---|---|---|---|
| Amount | Fixed | Fixed | Depends on results after completion |
| Documented in | Its own loan note instrument | The sale agreement | The sale agreement |
| Interest | Usually, often rolled up | Frequently none | None as such |
| How the senior lender ranks it | Intercreditor or subordination deed | The seller signs the deed, or each payment is made subject to the facility | As deferred consideration, and paid only if no default and the leverage test are met |
| Seller’s tax on the gain | Can be deferred, depending on structure | Normally taxed at completion | Depends on the structure |
| Main risk for the buyer | Rolled-up interest adds to the next refinancing | A blocked payment is a breach unless made subject to the facility | Disputes over how profit is measured |
Where the seller has not signed the subordination deed, the sale agreement should make each deferred or earn-out payment subject to the senior facility. Otherwise a payment the lender blocks puts the buyer in breach, and a seller who sues for it can push the facility into default as well. An earn-out that falls due while the senior facility is still amortising is met from the same cash flow as the debt service, so it belongs in the model from the day the targets look reachable.
On a buy-in, where the risk concentrates at the handover, as our guide to financing a management buy-in explains, an earn-out that keeps the seller engaged can be worth the risk of a dispute. When a departing shareholder is bought out, deferred consideration is one of the usual ways to spread the cost, as our guide to shareholder and partner buyouts sets out, but only where the continuing owners or a new holding company buy the shares. Outside an employees’ share scheme, a company buying back its own shares must pay for them on purchase. Companies Act 2006, section 691.
The structure decides when the gain is taxed, so advice comes before heads of terms.
Taking notes instead of cash changes when the seller’s gain is taxed, and whether Business Asset Disposal Relief applies to it. The treatment turns on how the notes are structured, including whether they are qualifying corporate bonds. In general, relief on the part of the gain taken in notes has to be claimed by reference to completion, which brings the tax on that part forward to before the notes are paid; left until repayment, that part will not usually qualify. HMRC, Capital Gains Manual CG64161. The relief is 18% on qualifying gains from 6 April 2026, up from 14% in the year before and 10% on or before 5 April 2025. GOV.UK, Business Asset Disposal Relief. It covers a lifetime total of £1 million of gains. GOV.UK, claiming the relief. Gains above that pay the main rate, which is 24% for a higher-rate taxpayer. GOV.UK, Capital Gains Tax rates.
If the notes are qualifying corporate bonds, the gain is fixed at completion and taxed when they are repaid even if they are never repaid in full, which is why sellers’ advisers usually prefer notes that are not. Where notes are issued in exchange for shares, advisers normally seek HMRC clearance, an application that belongs early in the timetable. The split between cash and notes is agreed in heads of terms, so the seller’s tax advice has to come before that; a seller who learns late that the notes cost more tax than expected tends to reopen the price.
We will size the notes against the debt before the price is agreed.
If the seller has offered, or been asked, to leave part of the price in, the useful first conversation is how the notes and the senior debt fit together, and whether the rate and repayment schedule on the table survive the downside case. It is confidential and costs nothing. We run the whole market against itself, bank and fund, and we will say plainly where the notes help the financing and where their terms will cost you at the next refinancing. See how a mandate runs in how we work, or the full range of what we advise on in our services.
The terms in this guide
Each is defined in full in the library, with the levels and conventions that apply at £3-15m.
- HoldCo vs OpCo debt
OpCo debt sits at the company that owns the assets and earns the cash. HoldCo debt sits one level above it, behind every creditor of the trading business, and is repaid only from what the trading company is permitted to pay up.
- Management buyout (MBO)
A management buyout is the team that runs a business buying it. The funding is a stack of senior debt, vendor paper and the team's own equity, and the hardest decision is taking less debt than the market will offer.
- Permitted payments
The permitted payments schedule sets what cash may leave the business while the debt is outstanding. It reaches further than dividends, and it is settled in the long-form documents rather than in the term sheet.
- PIK (payment in kind)
PIK interest is not paid in cash. It is added to the principal and repaid at the end, which protects cash flow today and enlarges the debt you have to refinance later.
- Shareholder buyout
Buying out a departing shareholder is an ownership shift funded by debt. The cash leaves the business, so a lender underwrites the remaining company's existing cash generation rather than a growth plan, which keeps leverage at the conservative end.