In deals involving the complete sale of a business, the owner (or vendor) can agree to a partially deferred payment (vendor finance). For example, if you wanted to buy my business for $100m, we could come to an arrangement whereby you pay $60m now and another $40m next year. Depending on who’s pulling whose levers, interest may be charged on the deferred payment. Also, there’s no rule to say it has to be paid in one year; it could be paid in instalments over three years, it could be paid in a lump sum in five years, or it could be paid when the new owner exits.
In private equity, vendor finance is another way to make a deal achieve the separate goals of the vendor and the investor. For example, if the vendor wants to sell for $100m, but the buyer thinks that is too much, he/she can suggest a deferred payment in the form of vendor financing. This isn’t because the buyer doesn’t have the pesos, it’s to reduce the real value of the deal. Remember time value of money? So, if the vendor finance amount is due in five years, it’s obviously not worth as much as what the same amount would be if paid today.
One other thing to remember is that vendor financing isn’t the same as an earnout. If the payment is at all contingent on future future, it’s an earnout, not vendor finance. In the other case where interest applies, the rate can be any amount that the parties agree. The private equity firm will usually insist on a rate that makes the deal right for them on an economic basis (remember, time value of money).