Vendor finance for a management buyout.

A vendor loan note is a debt instrument issued by the buyer to the seller, recording the slice of the purchase price that will be paid after completion. In an MBO the newco that acquires the shares issues the note, the seller holds it, and the trading company generates the cash that redeems it. Ownership changes hands on day one: the share purchase agreement completes, the register is updated, and the management team runs the business as owners while the note sits on the balance sheet as long-term debt.

The instrument is flexible in a way bank debt is not. Interest can be paid quarterly, rolled up to maturity, or a mixture of the two. Repayment can be level, back-ended, or linked to a cash sweep once senior covenants are met. Security is usually a second-ranking debenture or none at all. That flexibility is exactly why vendor finance appears in so many succession deals: it absorbs the risk that a lender will not price, and it lets a fair price survive contact with a funding model.

Background reading: what is a management buyout and how an MBO is structured.

Commonly 15 to 35 percent of the enterprise value, with 20 percent a reasonable planning assumption on a lower mid-market deal. The figure is not chosen in isolation. Start with the price, subtract the senior debt the business can service, subtract the cash the management team can genuinely put in, add back any asset based headroom, and the residue is what the vendor is being asked to defer. If that residue exceeds roughly a third of the price, most senior lenders will start asking whether the valuation is realistic rather than whether the note can be documented.

Debt capacity sets the ceiling. Lenders size term debt against EBITDA and free cash flow, typically 2.0x to 3.0x EBITDA of senior debt and 3.0x to 4.5x EBITDA including mezzanine or vendor debt, tested at a debt service cover ratio of about 1.3x. Every pound of vendor loan interest counts in that test, so a large note can crowd out the senior facility it was meant to complement. Working capital matters too: a deal that leaves the company with no headroom on day one will fail its first covenant test regardless of how patient the seller is.

Model a vendor loan note · Test debt capacity and DSCR

Because two lenders are now secured on the same business and the order has to be written down. A deed of priority, or an intercreditor agreement on larger deals, ranks the senior facility ahead of the vendor note and sets out what the vendor may and may not do. Typical terms: no cash interest or capital repayment to the vendor while a senior default is outstanding, no acceleration or enforcement without the senior lender's consent, no security beyond a second-ranking debenture, and a standstill period before the vendor can take any action.

Sellers find this the hardest part of the conversation, and it is worth explaining early. Subordination is not a comment on the seller's standing; it is the price of the senior debt that makes the day-one payment possible. In practice we negotiate permitted payment baskets so the vendor still receives interest and scheduled capital while the business performs, with the brake applying only on covenant breach. Getting that drafting agreed in principle before lawyers engage saves weeks and considerable fees.

See also personal guarantees in an MBO and the documents involved.

Capital gains tax on shares runs at 18 percent for basic rate taxpayers and 24 percent for higher rate taxpayers, and Business Asset Disposal Relief gives 18 percent on qualifying gains up to a £1 million lifetime limit from 6 April 2026, having been 14 percent in 2025/26. The timing question matters more than the rate. Where deferred consideration is ascertainable at completion, HMRC generally treats the whole gain as arising then, so tax can fall due before the cash arrives. Where it is unascertainable, such as a pure earn-out, the right to future payments is itself valued and taxed as part of the original disposal.

That is why the instrument is chosen with the seller's accountant in the room. Loan notes can be structured as qualifying corporate bonds or non-qualifying, with different consequences for when the gain crystallises and whether relief survives. Stamp duty on the share purchase is 0.5 percent, payable by the buyer where the consideration exceeds £1,000. All of this is HMRC territory and we are not tax advisers, so we work alongside yours rather than in place of them.

Detail in the MBO tax implications guide and valuation guide.

Worked example, illustrative only. A business generating £1 million of EBITDA is valued at five times earnings, so £5 million. Senior debt at 2.5x EBITDA provides £2.5 million over five years at an indicative 8.5 percent all-in. The management team invests £500,000 of its own cash, 10 percent of the price. A vendor loan note of £1 million at 6 percent over four years covers the balance, subordinated to the bank under a deed of priority, with interest paid quarterly and capital repaid from year two. Fees and working capital are funded separately. On year-one free cash flow of about £800,000, senior debt service cover lands near 1.3x. Figures are indicative as at September 2026 and not a quotation.

On the senior layer, names active in this market include Barclays, HSBC UK, Lloyds Bank, NatWest, Santander UK among the banks, and ThinCats, Caple, Growth Lending among the cash flow funders. That list is illustrative of names active in this market, not a recommendation, and appetite for sitting alongside a large vendor note varies considerably between them. Matt Lenzie brings 25 years in banking with significant transactional experience including buyouts, and more than £400m raised across the portfolio, which is mostly useful here for knowing which credit teams accept subordinated vendor debt without repricing the whole facility.

See the funder panel · Larger and sponsor-led transactions sit with our sister site LeveragedBuyoutFinance.co.uk.

Lenzie Consulting Ltd is not authorised or regulated by the FCA; we arrange unregulated business finance for limited companies and LLPs only.