The headline number and the real number
Vendor finance is where the seller leaves part of the agreed purchase price in the business at completion and the buyer repays it over time out of future trading, and a headline sale price that includes a vendor finance tranche is not the price the vendor actually receives. Vendor finance is common in Australian SME sales, particularly where bank finance is difficult to obtain or the buyer is an incoming working owner rather than a well-capitalised trade acquirer. A sale advertised at $2m with $1.2m paid at completion and $800k carried by the vendor over three years is not, economically, a $2m sale. The vendor has agreed to be an unsecured lender to their own former business, at a rate they did not set through a competitive lending market, with repayment contingent on the business continuing to perform under someone else's management. That risk has a price. If it is not deducted from the headline figure, the headline figure is not the price — it is the face value of a mixed cash-and-credit instrument.
Computing the effective price
The effective price of a vendor-financed sale is the cash received at completion plus the present value of the vendor finance tranche, discounted for time value and default risk — not the face value of the two added together. That is a straightforward present-value exercise, but the inputs are where sellers underestimate the discount. Two components need separate treatment: the cash-at-completion tranche, which is received at full value on settlement, and the vendor finance tranche, which is a stream of future payments carrying both time value and default risk. The vendor finance tranche should be discounted at a rate that reflects what an arm's-length unsecured lender would charge a small business buyer with the security package on offer — materially higher than a bank term loan rate, because vendor finance in SME sales is typically unsecured or only partially secured, and the borrower is often thinly capitalised and new to the asset. A discount rate in the high teens to mid-20s per annum is common for unsecured vendor paper on a small trading business; a well-secured tranche with a strong guarantor and a short term sits lower; a long, unsecured tail on a business with thin margins sits higher.
- ·Cash at completion: taken at face value
- ·Vendor finance tranche: discount the scheduled repayments at a rate reflecting unsecured SME lending risk, not the headline interest rate written into the loan note
- ·Adjust further for the probability-weighted loss in a default scenario, not just the discount rate — the two are related but not the same thing
- ·Compare the resulting effective price to the cash-equivalent price a buyer paying 100% at completion would need to offer for the seller to be economically indifferent
A worked illustration
Take an indicative $2m sale: $1.2m cash at completion, $800k vendor finance repaid over three years at a stated 8% coupon, unsecured, no personal guarantee. The stated 8% is the rate on the loan note — it is not the discount rate that should be applied to value the tranche, because 8% does not compensate for the actual risk being carried. Discounting the $800k repayment stream at a rate more consistent with unsecured SME lending risk (for illustration, in the high teens) rather than at 8% produces a present value for the vendor finance tranche that is meaningfully below its $800k face value — commonly a discount in the order of 15–25% of that tranche, depending on term, security and the buyer's covenant strength. On these illustrative figures the effective price sits closer to $1.75m–$1.85m than the advertised $2m. The gap is the discount nobody wrote down. This is illustrative only — every deal's actual discount depends on its own term, rate, security package and buyer risk, and should be modelled on the specific facts rather than assumed from any example.
Typical structures: term, interest, security
Vendor finance terms in Australian SME sales vary widely, but the structural elements that determine the real risk are consistent. Term is usually one to five years, with two to three years most common for trading businesses in the $500k–$5m range. Interest is either a stated coupon on the outstanding balance or, less commonly, an interest-free arrangement priced into a higher headline figure — the latter is a red flag for anyone trying to establish the arm's-length market value of the transaction, including for CGT purposes. Security is the variable that most affects the real discount: a General Security Agreement (GSA) registered on the Personal Property Securities Register (PPSR) over the business assets gives the vendor a registered interest ranking against other creditors, which materially changes the recovery position in a default or insolvency compared with an unsecured IOU. Personal guarantees from the buyer (and, where relevant, their spouse) add a second recourse path independent of the business's own solvency. A vendor finance tranche that is unsecured, unguaranteed and subordinate to a bank facility the buyer takes out to fund the cash-at-completion portion is a materially different — and materially riskier — instrument than one secured by a registered GSA ranking ahead of other unsecured creditors, with a personal guarantee behind it.
Default scenarios: the real downside of taking the business back
If a buyer defaults on vendor finance, the vendor's realistic recovery is rarely a clean cash outcome — it is enforcement, and enforcement of a vendor finance default usually ends in one of two outcomes, neither of which is attractive. The first is taking legal action against a buyer who may have limited personal assets beyond the business itself, with recovery uncertain and legal costs eroding whatever is recovered. The second — and the one vendors underestimate most — is taking the business back. A business that has defaulted on vendor finance has, in the overwhelming majority of cases, deteriorated since the sale: working capital has often been drawn down, key staff may have left, customer relationships may have weakened under new management, and the vendor is reacquiring an asset that requires immediate operating attention, not a clean cheque. Vendors who structure vendor finance assuming the security is a backstop that returns them to where they started are usually wrong. The realistic downside case should be modelled explicitly — not as 'we get the business back and it's fine,' but as 'we get back a damaged, smaller version of the business we sold, months after the last payment stopped, with legal costs already incurred and no guarantee the enforcement process concludes quickly.'
How vendor finance interacts with CGT timing
Vendor finance is taxed differently from an earn-out for CGT timing purposes, and that distinction is where sellers most often get the wrong answer by analogy. Under the general CGT timing rules in the ITAA 1997, capital proceeds — including the right to receive deferred instalments under vendor finance — are generally brought to account at the time of the CGT event (typically contract date), not as each instalment is later received, because a fixed, ascertainable right to future payments is itself capital proceeds with a market value at that time. This is different from a genuine earn-out, where Subdivision 118-I's look-through earnout right rules can apply because the future payments are not reasonably ascertainable at the time the right is created; a scheduled vendor finance repayment stream with agreed instalments and a stated rate is ordinarily ascertainable, so look-through earnout treatment does not typically apply to it. That makes establishing the market value of the vendor finance receivable — for cost-base and proceeds purposes at the CGT event — a live question, not a formality, particularly where the buyer's capacity to pay is doubtful. The ATO's market valuation for tax purposes guidance is the relevant starting point for how that value should be determined and evidenced. Vendors and their accountants should work through the CGT timing question before signing, not after — the tax cash flow implications of recognising a gain upfront on a headline figure that will be received in tranches, some of which may never eventuate if the buyer defaults, are a genuine planning issue. This is a tax-law question for the vendor's accountant or registered tax agent to resolve on the specific contract terms; Prismi prepares independent valuations only, is not a registered tax agent and does not provide tax advice. Where the valuation and CGT questions intersect, an independent valuation of the vendor finance receivable — prepared on a market value basis consistent with IVS 104 and APES 225 — is a distinct, defensible piece of evidence separate from the commercial negotiation.
Negotiation framing: price versus terms
Negotiating a vendor finance sale is a trade-off between headline price and terms, not a single number — a lower headline price with strong security and a short term can produce a higher effective price than a larger headline figure carried unsecured over a longer term. A buyer offering $2.2m with 50% vendor finance over four years, unsecured, may produce a lower effective price than a buyer offering $1.9m with 20% vendor finance over eighteen months, secured by a registered GSA and a personal guarantee. Sellers who anchor purely on the headline figure and let the buyer set the vendor finance terms as an afterthought are, in effect, negotiating away value they never priced. The more useful negotiation sequence is: agree the commercial value of the business first (ideally against an independent valuation range so both sides are anchored to evidence rather than opening positions), then treat every unit of vendor finance as a separate negotiation with its own price — security, guarantee, interest rate, term and default remedies all move the effective price of that tranche, and each should be negotiated with that in mind rather than accepted as boilerplate from a standard sale-of-business template.
Where an independent valuation fits
An independent valuation provides the anchor for a vendor finance negotiation: a defensible view of what the business is worth on a cash-equivalent basis, prepared before the vendor finance structure is discussed, so the headline price being offered can be tested against an evidence-led benchmark rather than accepted at face value because it is the biggest number on the table. Negotiating the vendor finance terms themselves — security, guarantee, interest rate and default remedies — remains a commercial and legal matter for the vendor, their lawyer and their accountant; the valuation's role is to establish the cash-equivalent value the terms are being negotiated around, not to negotiate them. Where the sale also has a CGT dimension — and most trading business sales do — that same valuation evidence supports the vendor's tax position on cost base and disposal value, prepared independently of the deal terms being negotiated.