Vendor Loan & Earn-Out

Vendor Loan and Earn-Out, Explained Simply: A Buyer’s View

When owners hear terms like vendor loan or earn-out, the first reaction is often emotional: “So I’m not getting paid in full?”
That reaction is understandable. But from a buyer’s side, these are not tricks or red flags by default. They are tools — sometimes necessary — to make a deal workable without overloading the business with debt or betting everything on assumptions that may or may not hold after closing.

I approach SME acquisitions as a lead buyer, staying responsible for the business after the deal, using a mix of my own financial resources, bank financing and, where appropriate, co-investors. That perspective shapes how I look at vendor loans and earn-outs: not as financial engineering, but as ways to balance risk, cash flow and behaviour after closing.

This article explains what these mechanisms really mean in practice — and when they help, or hurt, everyone involved.

Why these mechanisms exist in the first place

In many SME deals, there is a natural gap between what the owner believes the business is worth and what a buyer — and any bank involved — is prepared to pay upfront.

That gap usually comes from one or more factors:

• earnings look good, but are volatile or recently inflated;

• part of the performance depends heavily on the owner personally;

• the bank will only finance up to a certain level of debt;

• future growth is possible, but not yet proven.

Vendor loans and earn-outs are ways to bridge that gap without breaking the company.

They allow a deal to move forward where a pure “all-cash, day one” structure would either be impossible or irresponsible.

What a vendor loan really is

A vendor loan (sometimes called a seller loan) is simple in concept:

Part of the purchase price is paid over time as a loan from the seller to the buyer or the company.

Instead of receiving 100% of the price at closing, the seller becomes a lender for a portion of it.

How it looks in practice

Typical elements of a vendor loan include:

• Amount: usually a minority portion of the total price

• Term: often 2–5 years

• Interest: fixed or floating, reflecting risk

• Repayment: monthly, quarterly or annual

• Ranking: usually subordinated to bank debt

• Covenants: conditions linked to cash flow or leverage

From a buyer’s side, a vendor loan:

• reduces the need for bank or outside equity;

• improves alignment — the seller has money at risk alongside the buyer;

• often makes banks more comfortable, because the seller “stands behind” the business.

From a seller’s side, it means:

• you receive part of the price later, not upfront;

• you earn interest, but you also take credit risk;

• if the business struggles, repayment may be delayed or renegotiated.

A vendor loan is not “free money”. It is a bet on the future stability of the company under new ownership.

What an earn-out really is

An earn-out is different. It is not a fixed repayment. It is conditional.

Part of the price is paid only if the business reaches agreed performance targets after the sale.

Those targets are usually linked to:

• revenue,

• EBITDA,

• or a combination of operational metrics.

Why buyers use earn-outs

From a buyer’s perspective, earn-outs are used when:

• past performance may not be fully repeatable;

• growth is expected, but not guaranteed;

• results depend on market conditions or transition risk;

• the seller’s expectations are meaningfully higher than what current numbers support.

An earn-out says, in effect:
“If the business really performs as you believe it will, you will receive more.”

Why sellers underestimate the complexity

Earn-outs often sound simple in headlines, but they are detail-heavy and fragile in reality.

Key questions that matter enormously:

• What exactly counts as EBITDA?

• Which costs are excluded or included?

• Who controls investment decisions during the earn-out period?

• What happens if the buyer changes strategy or integrates the business?

• What if the seller is no longer involved day-to-day?

Once the seller no longer controls the company, their ability to influence outcomes is limited — even if their money depends on those outcomes.

That is why earn-outs tend to be the most disputed part of SME deals.

How buyers think about these tools together

From a buyer’s side, vendor loans and earn-outs are not interchangeable. They solve different problems.

• Vendor loan:

  • used to reduce upfront cash and align interests;

  • fixed obligation, if the business can support it;

  • increases leverage tolerance without relying on optimistic forecasts.

• Earn-out:

  • used to bridge valuation gaps driven by uncertainty;

  • transfers performance risk back to the seller;

  • protects the buyer from paying today for results that may never materialise.

A disciplined buyer uses these tools to answer one core question:

Can the business realistically service all obligations — bank debt, vendor loan, investments — without suffocating itself?

If the answer is no, the structure is wrong, regardless of how attractive the headline price looks.

When these structures help — and when they don’t

Situations where they make sense

Vendor loans and earn-outs can be constructive when:

• the business has stable cash flow, but banks are conservative;

• the seller wants a higher price than current numbers justify;

• there is a genuine transition period where seller involvement adds value;

• both sides accept that risk must be shared, not hidden.

In these cases, they can unlock deals that are fair and sustainable.

Situations where they become dangerous

They become problematic when:

• the business is already highly leveraged;

• cash flow is thin or volatile;

• earn-out targets are aggressive and loosely defined;

• the seller’s payout depends on decisions they no longer control;

• multiple layers of obligations pile up on the company.

At that point, the structure stops being a bridge and becomes a trap — for the seller, the buyer and the management team left inside the business.

What really matters to sellers

From a seller’s perspective, the key is not whether an offer includes a vendor loan or an earn-out. The key is how exactly they work.

Useful questions to ask:

• How much of my price is truly fixed, and how much is conditional?

• Under what scenarios could payments be delayed, reduced or cancelled?

• Who controls reporting, budgeting and investment decisions?

• What happens if the business has one bad year, even temporarily?

• Does the company realistically have room to carry these obligations?

These questions matter far more than the labels used in the term sheet.

A shared language helps everyone

For owners, investors and advisors, understanding vendor loans and earn-outs in practical terms creates a shared language.

Instead of reacting emotionally to “I don’t get paid in full”, the discussion becomes:

• what risk is shared,

• what risk is transferred,

• what the business can safely support,

• and what each party is really betting on.

That shift alone often leads to better decisions — and fewer regrets later.

If This Is Part of a Real Conversation for You

If vendor loans or earn-outs are coming up in discussions around a real business, it’s worth slowing down and breaking them into concrete terms: timing, conditions, control and downside scenarios. If you’d like to follow more practical notes like this on how SME deals are actually structured, you can subscribe to the weekly field notes on my site — a short, buy-side perspective each week, focused on how deals work in practice rather than in theory.