What Happens to Business Debt and Loans When You Sell

Start with a complete list of what you owe

Sit down with the balance sheet, the bank statements and the credit card statements, and write out every obligation. Most owners find at least one they had forgotten. The list normally includes term loans from a bank, a line of credit, equipment financing, vehicle loans, credit cards in the company's name, loans from the owner or from family, leases for equipment or vehicles, unpaid sales tax and payroll tax, and money owed to vendors. Some businesses also have an SBA loan, a merchant cash advance, or a loan from a landlord for build-out costs.

For each item, find the lender, the balance, the interest rate, the monthly payment and the end date. Look for early payoff charges, because many loans impose a fee for being paid off ahead of schedule. Then find out whether you signed a personal guarantee, whether the loan is secured by specific equipment or by everything the business owns, and whether any document restricts a sale of the company without the lender's consent.

This list serves two purposes. It tells you what is likely to come out of the sale price at closing, and it shows a buyer you know your own business. A seller who cannot say what the company owes loses a buyer's confidence early. Our guide on getting your financials ready for a buyer explains how the debt schedule fits with the rest of the records.

The usual outcome: paid off at closing

In most sales of small and midsize companies, the buyer does not take over the seller's debt. The buyer pays the price, and the closing statement directs part of it to each lender, who releases its claim on the business and its assets. The seller receives whatever is left. A title or escrow company, or the attorneys, handle the mechanics and obtain a payoff letter from each lender stating the exact amount due on the closing date, including interest and any fee.

This works because most buyers want to start with clean ownership. A buyer who is paying for the assets of a business, or the stock of a company, wants to know that no lender has a claim on the equipment or the receivables. The lender releases its lien when it is paid, and the buyer's own lender then takes a new lien if there is acquisition financing. Our post on asset sales and stock sales explains how the structure affects what the buyer takes on.

For you, that means the number that matters is the net after debt. A company sold for a certain price with a large balance on its loans may put less in your pocket than a smaller sale of a company with none. When you compare offers, ask each buyer to show you the sources and uses at closing. That is the simple table that lists where every dollar goes.

Allow time for payoff letters. Banks sometimes take several days, and a closing can be delayed by a lender that is slow to respond. Ask your attorney to request them early.

Equipment loans, leases and what the buyer wants to keep

Equipment is where sellers meet the most surprises. If you financed a piece of equipment, the lender holds a lien on it and you cannot sell it free and clear until the loan is paid or the lender agrees to a transfer. A buyer who wants the equipment will often ask that the loan be paid off at closing, or occasionally that the buyer take over the loan with the lender's approval.

Leases are different from loans. A lease means someone else owns the equipment, and the company has the right to use it. The lease may allow assignment to a buyer, may require the lessor's consent, or may carry a payment for early termination. A tractor, a delivery van, a copier or a piece of medical equipment can all be leased, and a buyer wants to know which of those the company owns. Ask the lessor early about what it would take to transfer or end the lease.

Vehicles bring their own rules. A bank holding a lien on a truck normally holds the title, and the title has to be released and reissued in the buyer's name. The process differs by state and your attorney confirms what applies.

One common complication is cross-collateralization, where a single lender's loan documents tie all of the company's loans together. Paying off one may not release the security for another. Read your loan documents carefully, since a lender can hold equipment you thought was free until every obligation is cleared.

Personal guarantees follow you

If you guaranteed a company loan personally, your name is on the debt even after the business changes hands. A sale does not release the guarantee. It remains in force until the lender releases it in writing, and a lender has no reason to do so unless it is paid in full or replaced with a stronger obligor.

In most closings this is simple, because the loan is paid off and the guarantee ends with it. It becomes a problem when the buyer assumes a loan, or when a lease is assigned. A landlord who holds your personal guarantee on the lease will not usually release it simply because a new tenant takes over. You will need to ask, and you may need to negotiate. The landlord could ask for a security deposit from the buyer or require the buyer's own guarantee. Our post on the lease as part of the deal goes through that conversation.

If you cannot get a release, ask the buyer for an indemnity, which is a written promise to cover you if the lender comes after you. Make sure the buyer can afford that promise. A guarantee from a thinly funded new company is thin protection.

Keep copies of every release. Years later, when someone asks whether a guarantee ended, the signed release is the only answer that counts.

SBA and bank loans that stay in place

Occasionally a buyer takes over an existing loan. This happens most often with long-term, low-rate financing that is attractive to keep, such as a loan on a building or equipment. It needs the lender's written consent, and the lender will underwrite the buyer as it would a new borrower. Some loan documents give the lender the right to call the entire balance due upon a change of control, and a sale usually triggers that clause.

An SBA loan is handled in a particular way. The government-backed lender has to approve any transfer of the loan, and the buyer must qualify. More often the SBA loan is paid off at closing, and the buyer takes out its own acquisition loan. If you borrowed under an SBA program, ask your lender for the exact payoff and for the lender's rules on prepayment, which can include a fee in the early years of the loan.

Lines of credit are usually closed. Any balance is repaid at closing, and the lender releases the lien on the receivables and inventory. Credit cards are paid and canceled, or transferred to the new owner's own accounts.

If you want to keep an existing loan because its terms are unusually good, tell your advisor at the start. It affects how we structure the offer and which buyers we approach. Sometimes it can be a selling point, and sometimes the lender simply says no.

Taxes, vendors and the bills that arrive late

The quietest debt in a sale is the kind that has not been billed yet. Unpaid payroll taxes, sales tax and income tax can attach to the business or to the seller after a closing. In an asset sale, a buyer may ask for a tax clearance or hold back part of the price until the seller proves taxes are current. In a stock sale, the buyer inherits the company's history and will ask for strong protection against anything that surfaces later.

Vendors matter too. A company that stretches its payables to cover a cash crunch is carrying a hidden loan. Buyers see it in the accounts payable aging and treat it as debt, which reduces what they will pay. If your payables are older than your normal terms, bring them current before you go to market.

Customer deposits and gift cards are liabilities even though no bank is involved. If the company has taken money for work not yet done, the buyer has to deliver on it, and the price often reflects that. Deferred revenue, accrued vacation and unpaid bonuses are handled the same way. Our post on earnouts, holdbacks and working capital covers how these items are settled in the price.

Finally, ask what you owe the owners. Loans from you to the company, or from family members, are often repaid at closing, and sometimes forgiven as part of the deal. Your accountant should explain the tax effect before the paperwork is signed.

What to do before you list

Collect the loan documents and put them in one folder. Call each lender and ask for a current balance, the payoff process and any prepayment fee. Mark every personal guarantee. Ask your accountant to confirm that taxes are filed and paid. Then decide whether to pay anything down before you sell. Sometimes it is worth it, and sometimes the cash is better kept for the business through the sale.

Once you know the net you would receive under a few different prices, you can judge offers with a clear head. Business Advisors of America prepares that sources-and-uses view for every owner we work with, because the number on the offer is rarely the number on the wire.

This article shares our opinion and general information. It is not legal or tax advice. Always speak with a licensed attorney for legal advice, and a qualified tax professional for tax questions, before you act.