Q&A: Deferred Consideration & Security

Q. What is deferred consideration in a share sale? 

Deferred consideration is any element of the purchase price that is not paid in full on the day of completion. It arises in a variety of deal structures and for a variety of reasons. Common forms include: 

• Earn-out payments — additional consideration payable if the business meets agreed financial targets after completion. 

• Instalment payments — the price is paid in tranches over a defined period, whether or not contingent on performance. 

• Vendor loans — the seller effectively lends part of the price back to the buyer, to be repaid over time with interest. 

• Completion account adjustments — where the final price depends on an agreed financial measurement taken after completion, and a balancing payment is made by whichever party is ‘short’ under the mechanism. 

Deferred consideration changes the seller’s risk profile fundamentally. Once the shares are transferred, the seller no longer owns or controls the business. Their security for the deferred payment is entirely contractual — and if the buyer defaults, the seller must pursue a claim against someone who now controls the asset that was the subject of the sale. Appropriate security for deferred payments is therefore not optional; it is essential. 

Q. What security can a seller obtain for deferred consideration payments? 

English law provides a range of security mechanisms that sellers can seek to protect deferred consideration obligations. The most common are: 

• Personal guarantee — a promise by one or more individuals (typically the buyer’s principals) to meet the deferred payment if the buyer entity defaults. Direct and effective, but buyers — particularly institutional buyers and private equity houses — almost always resist personal liability. 

• Corporate guarantee — a guarantee from the buyer’s parent company or an entity within the buyer’s group. As effective as a personal guarantee if the guarantor entity is creditworthy. 

• Debenture (fixed and floating charge) — security over the assets of the buyer company. Registered at Companies House; gives the seller priority in an insolvency. May rank behind existing senior lenders. 

• Legal mortgage over property — if the buyer or the target owns real property, a registered charge over that property provides strong, tangible security. Enforcement through power of sale is straightforward if the charge is validly registered. 

• Share pledge (charge over target shares) — the buyer grants a charge over the shares in the acquired company back to the seller. If the buyer does not pay, the seller can enforce the pledge and retake ownership of the target. A powerful mechanism, but its value depends on the target’s continuing financial health. 

• Escrow or cash retention — a sum is held by a neutral third-party agent and released to the seller on the satisfaction of specified conditions. Ring-fenced from the buyer’s creditors in an insolvency. Requires the buyer to have — and commit — the funds at completion. 

• Bank letter of credit — an irrevocable undertaking by the buyer’s bank to pay a specified sum to the seller on demand. The strongest alternative to a personal guarantee, but carries a financing cost for the buyer. 

Q. What alternatives to a personal guarantee can a buyer offer? 

The personal guarantee is the form of security sellers most commonly request and buyers most commonly resist. For buyers who cannot or will not provide personal guarantees — a position taken by virtually all institutional, private equity and family office buyers — the following alternatives offer meaningful protection: 

• Corporate guarantee from a creditworthy parent: If the buyer is an SPV, a guarantee from the ultimate holding company or a well-capitalised group entity is often the most commercially acceptable solution. The seller should carry out its own credit assessment of the guarantor. 

• Escrow funded at completion: The most robust alternative from a seller’s perspective. Funds in escrow are ring-fenced, independent of the buyer’s solvency, and require no enforcement — the seller simply instructs the escrow agent when the trigger conditions are met. 

• Bank letter of credit: Provides bank-grade security with no personal liability for any individual. The buyer’s bank issues an irrevocable payment undertaking. The cost is borne by the buyer in the form of bank fees and impact on credit facilities. 

• Share pledge over the target: The buyer grants a charge over the shares it has just acquired. If the consideration is unpaid, the seller can retake the business. This is often commercially acceptable to buyers as it limits exposure to losing the acquisition rather than personal assets. 

• Debenture over buyer’s assets: Where the buyer has assets, a registered debenture provides priority in an insolvency. Less effective where the buyer is an asset-light acquisition vehicle with senior lenders holding prior-ranking charges. 

Q. What is a vendor loan note? 

A vendor loan note (also called a vendor loan or a vendor loan note instrument) is a document issued by the buyer to the seller acknowledging a debt owed in respect of deferred consideration. It is, in effect, a formal IOU — the buyer borrows the deferred portion of the purchase price from the seller, to be repaid over time with interest. 

Vendor loan notes are documented by a loan note instrument, which sets out the principal amount, the interest rate, the repayment schedule and the events of default that allow the seller to accelerate repayment. They can be secured (backed by a debenture or other security interest) or unsecured. They may also be structured as convertible instruments, allowing the seller to convert the outstanding balance into equity in the buyer under certain conditions. 

A key practical issue is subordination. Where the buyer has raised senior debt from a bank to fund the acquisition, the bank will almost invariably require the vendor loan note to rank behind the bank debt — meaning the seller is only repaid after the bank has been fully repaid. This significantly reduces the security value of the loan note. Sellers should consider whether additional security (such as a share pledge or property charge) is available alongside the loan note. 

Q. What happens if an earn-out is disputed? 

Earn-out disputes are among the most common and most bitterly contested post-completion disputes in M&A. They typically arise in one of three ways: 

• Accounting policy disputes — the parties disagree on how the earn-out metrics (usually revenue, EBITDA or profit) should be calculated, often because the SPA did not define the applicable accounting policies with sufficient precision. 

• Management conduct disputes — the seller alleges that the buyer has managed the business in a way that artificially depressed the earn-out metrics — for example, by charging excessive management fees, diverting revenues to other group companies, or failing to maintain adequate marketing spend. 

• Integration disputes — post-acquisition integration of the target into the buyer’s group makes it difficult or impossible to calculate the target’s standalone performance as contemplated by the earn-out. 

Prevention is better than cure. The earn-out provisions in the SPA should define the metrics with precision, specify the applicable accounting policies, impose obligations on the buyer to operate the business in a way that gives the earn-out a reasonable opportunity to be achieved, and include restrictions on the buyer’s ability to make changes (such as changing accounting policies, diverting business, or loading costs) that would depress the earn-out. 

Where a dispute has already arisen, the SPA should contain an expert determination provision under which an independent accountant is appointed to resolve disputes about the earn-out calculation. This is faster and cheaper than litigation, though it does not address allegations of deliberate manipulation by the buyer.