Deferred Consideration in a Business Sale

Deferred consideration is the part of the price for a business that the buyer pays after completion rather than on the day. It is a fixed sum, agreed and written into the sale agreement before you sign, payable on dates you have already set, and the critical point for a seller is that it is a contractual debt and nothing more unless you take security for it.

That distinction decides almost everything that follows. A seller with security can enforce against an asset if the buyer does not pay. A seller without security joins the queue of unsecured creditors and, in a bad outcome, recovers very little of it. Most published guidance on deferred consideration lists the security options and stops. This article sets out what each one actually delivers when you come to enforce it, where each falls down, how buyers use set-off to reduce what they pay, and where you rank if the buyer fails.

What deferred consideration actually is

In a typical structure, a buyer agreeing a price of £2 million might pay £1.4 million at completion and the remaining £600,000 in two instalments of £300,000 on the first and second anniversaries. The £600,000 is deferred consideration. The amount is fixed at completion. Nothing the business does afterwards changes it.

Deferred consideration appears in both share sales and asset sales, and the mechanics differ in an important way. On a share sale, the buyer owns the company from completion and the deferred amount is a debt owed by the buyer to you personally. On an asset sale, the buyer owns the assets and the debt is owed to the selling company. In both cases the obligation sits in the sale agreement, and the strength of your position depends entirely on what you negotiated to sit alongside it. If you have not yet decided between the two structures, that choice drives a great deal more than the payment mechanics, and we cover the full picture in our legal guide to selling a business.

Deferred consideration is not an earn-out

These two are frequently used as if they were interchangeable. They are not, and conflating them is one of the more expensive mistakes we see sellers make.

Deferred consideration is a fixed sum payable later. An earn-out is a variable sum calculated by reference to how the business performs after completion, usually against revenue, gross profit or EBITDA targets over one to three years. With deferred consideration you know on day one exactly what you are owed. With an earn-out you do not, and the person who controls whether you get paid is the buyer who now runs the business.

Deals routinely contain both. A price might be structured as cash at completion, a fixed deferred instalment at twelve months, and an earn-out running to year three. The protections for each are different, and an agreement that treats them as one block of “deferred payments” tends to protect neither properly. The additional covenants an earn-out needs are set out in our article on how earn-outs work and how to protect yourself.

Why buyers ask for deferred consideration

It is worth understanding the buyer’s reasoning, because it tells you which protections they are likely to concede and which they will fight.

• Funding. The buyer cannot or does not want to raise the whole price in cash. Deferring part of it closes a funding gap without a lender, and without a lender’s covenants.
• Risk transfer. Money still in the buyer’s hands is the simplest possible remedy for a warranty breach. A buyer with £600,000 outstanding has a far cheaper route to compensation than one who has to sue you for it.
• Valuation disagreement. Where the parties cannot agree what the business is worth, deferring part of the price postpones the argument.
• Keeping the seller engaged. Where the seller is staying on for a handover period, an unpaid balance is an incentive to make that handover work.

The second of those is the one to watch. A buyer who wants deferred consideration primarily as a warranty reserve will resist anything that puts the money beyond their reach, which is precisely why the set-off drafting matters as much as the security drafting.

The risk a seller carries without security

An unsecured deferred consideration obligation gives you a right to sue. It gives you nothing to seize. If the buyer refuses to pay, your remedy is proceedings, judgment and enforcement, which takes time and costs money, and which is worth nothing at all if the buyer has no assets by the time you get there.

The exposure is worse on a share sale than most sellers appreciate. The buyer is often a newly incorporated acquisition vehicle with no trading history, no assets of its own and no balance sheet beyond the shares it has just bought from you. If that vehicle fails, there is nothing behind it. You sold a solvent business and became an unsecured creditor of a shell.

The security a seller should ask for

Security converts a promise into a claim against something. The options below are the ones that work in practice on SME deals. Most sellers end up with a combination rather than one, and the right combination depends on who the buyer is and what they own.

Charges over shares and over the target’s assets

A charge over the shares you have just sold is the most natural security on a share sale, and the most commonly conceded. It is normally supported by a stock transfer form executed in blank and held by your solicitors, together with the share certificate, so that enforcement does not depend on the buyer’s cooperation.

Its weakness is timing. If you enforce two years after completion, you take back a business the buyer has been running, possibly badly, and which may now carry debt it did not have when you sold it. Negative covenants matter here: restrictions on the company borrowing, granting security, disposing of assets or paying dividends while the deferred amount is outstanding. Without them, the asset your charge bites on can be hollowed out entirely lawfully.

A debenture over the target company’s own assets is stronger where you can get it, but it almost never survives contact with an acquisition lender. If the buyer is borrowing to fund the purchase, the bank will take first ranking security and you will be asked to sign a deed of priority or an intercreditor agreement subordinating your claim. Read that document carefully. It frequently prevents you from enforcing, or even from demanding payment, without the lender’s consent.

Guarantees

A parent company guarantee is the right ask where the buyer is a subsidiary in a larger group. The value of it depends entirely on the guarantor, so check the guarantor’s filed accounts rather than accepting the name on the notepaper. A guarantee from another asset-light holding company in the same structure adds nothing.

Personal guarantees from the buyer’s owners or directors are the most contested security on most SME deals, and often the most effective. They tend to change behaviour in a way that corporate security does not. If you obtain one, insist that each guarantor takes independent legal advice and that this is recorded, because a guarantee given without it is more vulnerable to challenge later. We provide independent legal advice on guarantees in exactly this situation.

Escrow and retention accounts

An escrow or retention account is the only arrangement on the list that removes credit risk rather than managing it. The money is paid at completion into a joint account, usually held by the two firms of solicitors, and released on dates and conditions agreed in advance.

The drafting that matters is the release mechanism. Specify the release dates, what a buyer must do to block a release (a claim notified in writing, quantified, and meeting a minimum threshold), what happens to a blocked amount if the claim is not pursued within a set period, who gets the interest, and how a dispute over release is resolved. An escrow agreement that allows the buyer to block release simply by asserting a claim is little better than no escrow at all.

Registering security correctly

Security granted by a company must be registered. Under section 859A of the Companies Act 2006, the period allowed for delivery to Companies House is 21 days beginning with the day after the date the charge is created. Miss it, and section 859H makes the charge void, so far as the security it confers is concerned, against a liquidator of the company, an administrator of the company and any creditor of the company. The debt survives and becomes immediately payable, but the security does not.

That is an unforgiving deadline on a document signed in the middle of a completion. It is also entirely avoidable, and it is one of the reasons taking security is a job for a solicitor rather than something to bolt on afterwards.

Set-off against warranty claims, and how to limit it

Set-off is the right to reduce what the buyer pays you by the amount of a claim they say they have against you. It is where deferred consideration is most often lost, and it rarely involves a court.

If the sale agreement gives the buyer a general right of set-off, they can withhold payment on the strength of an asserted warranty or indemnity claim. You are then the party who has to sue, for your own money, against a buyer who is sitting on it. The commercial pressure runs entirely the wrong way, and an unmeritorious claim becomes a cheap negotiating tool.

The protections to negotiate are specific:

• Exclude set-off entirely where you can, so that deferred consideration is payable in full on the due date and any claim is pursued separately. Buyers resist this, but it is the right opening position.
• If set-off is conceded, limit it to claims that have been admitted in writing by you or determined by a court or agreed expert. An asserted claim should not be enough.
• Require the claim to be notified and quantified in writing before the due date, with reasonable detail of the breach and the loss.
• Apply a de minimis and an aggregate threshold so that small claims cannot interfere with payment at all.
• Cap the total that can ever be set off, and keep that cap consistent with the overall liability cap in the warranty limitations.
• Require any disputed amount to be paid into escrow rather than retained by the buyer, so neither side has the benefit of the money while the dispute runs.
• Set a long stop, so that an amount withheld against a claim not formally pursued within, say, six months becomes payable with interest.

Set-off interacts directly with the warranty limitations in the sale agreement and with what you disclosed against them, so these clauses need to be drafted as one package rather than negotiated separately by different people on different days.

One further point that catches sellers out: if the buyer goes into liquidation, set-off stops being a matter of negotiation. Rule 14.25 of the Insolvency (England and Wales) Rules 2016 requires an account to be taken of mutual dealings between the company and a creditor, and the sums due from each must be set off against the other. Only the balance is provable. If the buyer’s liquidator believes the company has a claim against you, that claim is netted off automatically against the deferred consideration you are owed, whatever the contract says about set-off.

Interest: there is no automatic right to it

Sellers often assume that late payment attracts statutory interest. On a share sale it does not. The Late Payment of Commercial Debts (Interest) Act 1998 applies, under section 2(1), to contracts for the supply of goods or services. Shares are things in action and are excluded from the definition of “goods” in section 61 of the Sale of Goods Act 1979, so the sale of a company’s shares falls outside the Act. If you want interest, it has to be in the contract.

Two separate rates are worth writing in. First, interest on the deferred amount while it is outstanding, which compensates you for not having the money and discourages the buyer from treating your deferred consideration as free credit. Second, a higher default rate on late payment, commonly expressed as a margin of 4 to 8 per cent over the base rate of a named clearing bank, which is a genuine deterrent rather than merely compensatory.

Pair this with an acceleration clause: if one instalment is missed and not remedied within a short cure period, the entire outstanding balance falls due immediately, with interest. Acceleration is what turns a missed payment into a single enforceable debt rather than a series of small arguments spread across years.

What happens if the buyer sells the business on

This is the scenario most sale agreements handle badly. The buyer acquires your company, trades it for eighteen months, then sells it to someone else while your deferred consideration is still outstanding.

If your security was a charge over the shares, a sale of those shares by the buyer threatens the only asset your security bites on. If your comfort was that the buyer was a solid trading group, a change of control in that group removes it. Protect against this expressly:

• An acceleration trigger on a change of control of the buyer or of the target company, so the balance becomes payable on completion of any onward sale.
• A restriction on disposing of the target shares or of the business and assets while any deferred consideration is outstanding, unless you are paid in full or the buyer provides equivalent security.
• A requirement that any onward buyer enters a deed of adherence, assuming the payment obligation and granting you equivalent security.
• A prohibition on the target granting security that ranks ahead of yours, and on dividends or other distributions out of the target while the balance is unpaid.
• Notification obligations, so you learn about a proposed sale before it completes rather than afterwards.

Note that the buyer cannot transfer the obligation to pay you simply by selling the company on. A contractual burden cannot be assigned without the agreement of the party entitled to performance. In practice that means the original buyer remains liable, which is useful but less useful than it sounds if the original buyer is an acquisition vehicle whose only asset has just been sold.

If the buyer fails: where an unsecured seller ranks

This is the part most guidance summarises as “you become an unsecured creditor” without explaining what that means in money terms. It is worth being precise, because the ranking is what makes security worth negotiating hard for.

On a liquidation or administration of the buyer, realisations are applied broadly in this order:

• Holders of fixed charges, out of the assets subject to those charges.
• The expenses of the insolvency process, including the office holder’s fees.
• Preferential debts, which include employee claims and, since the Finance Act 2020 inserted paragraph 15D into Schedule 6 of the Insolvency Act 1986, certain HMRC debts such as VAT and taxes deducted at source.
• The prescribed part, a slice of floating charge realisations ring-fenced for unsecured creditors under section 176A of the Insolvency Act 1986.
• Holders of floating charges.
• Unsecured creditors, who share whatever remains pro rata.

The prescribed part is the only statutory comfort an unsecured seller gets, and it is modest. Under the Insolvency Act 1986 (Prescribed Part) Order 2003, it applies only where the company’s net property is at least £10,000, and is calculated as 50 per cent of the first £10,000 and 20 per cent of the excess, subject to an overall cap. That cap was raised from £600,000 to £800,000 by the Insolvency Act 1986 (Prescribed Part) (Amendment) Order 2020 for floating charges created on or after 6 April 2020. The £800,000 is shared among all unsecured creditors, not paid to you.

So a seller owed £600,000 of unsecured deferred consideration, ranking alongside trade creditors and HMRC’s non-preferential claims, may recover a few pence in the pound. A seller holding a validly registered fixed charge over a property worth £600,000 recovers in full. That is the whole argument for taking security, and it is why we would rather negotiate hard on this point at heads of terms stage than explain it afterwards. If you are already in that position, our creditors insolvency team can advise on proving and on enforcing any security you do hold, and our commercial dispute solicitors on recovery where the buyer is solvent but refusing to pay.

The tax timing trap: taxed now, paid later

Deferred consideration that is ascertainable at the date of disposal, which fixed instalments almost always are, is brought into the capital gains computation in full at the time of the disposal. It is taxed when you sell, not when you are paid.

The authority is section 48 of the Taxation of Chargeable Gains Act 1992, which requires consideration to be brought into account without any discount for postponement of the right to receive it, and without regard to the risk of any part being irrecoverable or to the right to receive it being contingent. HMRC’s Capital Gains Manual at CG14881 puts it plainly: where the amount of future consideration is ascertainable, the full amount is included in the disposal proceeds, and there are no tax consequences when the future amounts are received.

The practical consequence is a cash flow problem. A seller receiving £1.4 million at completion with £600,000 deferred may have a capital gains tax liability calculated on the full £2 million, payable before the deferred instalments arrive. Two statutory reliefs are worth knowing about:

• Section 280 TCGA 1992 allows the tax on a chargeable gain to be paid by instalments, at the option of the person making the disposal, where consideration is payable by instalments over a period exceeding 18 months. The instalments are such as HMRC may allow, over a period not exceeding eight years and ending no later than the last of the consideration instalments.
• Section 48 relief for irrecoverable consideration. If part of the consideration brought into account subsequently proves irrecoverable, an adjustment can be made on a claim to that effect, by discharge or repayment of tax. HMRC’s guidance on this is at CG14930.

Unascertainable deferred consideration, which is what an earn-out usually is, is treated differently again. It is valued as a separate right at the date of disposal and the subsequent receipts are dealt with on their own footing, which is covered in HMRC’s manual from CG14940.

We set out the legal position here, not tax advice. Rates, allowances and the availability of reliefs such as Business Asset Disposal Relief change, and the right answer depends on your own circumstances. Confirm your position with your accountant or tax adviser before you agree a payment structure, not after, because the structure itself is what drives the outcome.

What to settle before you sign

By the time a sale agreement is circulating, the commercial terms are largely fixed and the leverage has gone. These are the points to put into heads of terms, where they are still negotiable:

• The split between cash at completion and deferred consideration, and the payment dates.
• What security is being provided, by whom, and over what. Name the assets.
• Whether a bank is funding the purchase, and what the deed of priority will say about your right to enforce.
• Whether set-off is permitted, and if so, on what conditions.
• The interest rate on the deferred amount and the default rate on late payment.
• Acceleration on default, on insolvency, and on a change of control.
• Restrictions on the target borrowing, granting security, disposing of assets or paying dividends while the balance is outstanding.
• Whether an escrow is being used, and the exact release mechanics.

These points interact with the completion mechanism as well. Whether the deal uses completion accounts or a locked box changes when the price is finally fixed and what can still be adjusted after completion, and we cover that choice in our comparison of completion accounts and locked box structures. Deferred consideration is also common in professional practice sales, where the handover period and regulatory transfers add their own timing pressures, as we set out in our article on selling a dental practice.

The buyer’s side of the same question

We act for buyers as often as sellers, and the buyer’s concerns here are legitimate rather than tactical. A buyer taking on a business they have only seen through due diligence has a real interest in retaining some leverage until the warranties have had time to bite, and a seller who refuses every form of set-off and every retention is usually making the deal harder rather than safer.

The workable answer is almost always structural rather than adversarial. An escrow that holds a properly sized retention, on release terms that are objective and time limited, gives the buyer a genuine remedy and gives the seller certainty that the money exists and will be released. It is a better outcome for both sides than an unsecured deferred payment with a wide set-off right, which protects the buyer at the seller’s expense and generates disputes. Where you are on the buying side, our guidance on buying a business takes the same points from the other direction.

Talk to us before the structure is agreed

Deferred consideration is not a drafting detail. It decides whether you are paid, and the time to fix it is at heads of terms, before the commercial shape of the deal has hardened. We advise sellers and buyers on selling a business, buying a business, mergers and acquisitions and management buy-outs and buy-ins, and on the commercial contracts and security documents that sit alongside them.

If you are negotiating a sale with part of the price deferred, or you are owed deferred consideration and the payment date has passed, we would be glad to talk it through. Call us on +44 207 566 1188 or email info@gurvelegal.com.