Holly founded ExitPromise.com as well as StartupPromise.com and so far has answered more than 3,000 questions asked by business owners about starting, growing and selling a business.
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Entrepreneurs may often be under the wrong impression that their business debt will disappear when the business is sold. In some cases, the debt is absorbed or is assumed by the buyer. But usually this is not the case.
Knowing what happens to business debt when selling a business is a critical part of the exit planning process and in determining which buyer is making the best offer.
The pandemic introduced PPP Loans, which may not be forgiven by the SBA, further complicate things. The SBA issued a Procedural Notice to address how to handle an outstanding PPP Loan when selling a business.
Furthermore, understanding how the debt on the company’s books ultimately affects the purchase price paid by a buyer or investors is important. And regardless of how the business is transferred, it’s important to understand how debt on the company’s books influences the price paid by the buyer or group of investors.
Stock vs. Asset Sale
While larger businesses and those sold in the public markets are typically sold under a Stock Purchase Agreement, such transactions can occur in the lower-middle and middle market. Stock sales are consummated with the transfer of the common and/or preferred shares of stock to a new owner. When this occurs, the buyer or investor is responsible for all debt and liabilities recorded on the books, as well as any undisclosed liabilities which may be present. Because of this, many small businesses are not sold under a ‘stock sale’ arrangement.
Asset sale arrangements between a business owner and a buyer involve the transfer of title to certain assets and in some cases certain liabilities. The combination of assets and liabilities transferred in an ‘asset sale’ is varied and subject to negotiation.
For example, in an asset sale a buyer may purchase the Inventory and one half of the Accounts Receivable while assuming all of the Trade Accounts Payable. The seller may retain one half of the Accounts Receivable and the Line of Credit. Any combination of Assets and Liabilities may be transferred to a buyer and/or retained by the seller in an asset sale transaction. A better term for an asset sale may be a non-stock sale.
As you can imagine, every buyer wants to acquire different assets and may be agreeable to assume certain forms of debt or liabilities, so comparing multiple offers in an apples-to-apples fashion can be challenging.
To further complicate the comparison process, each asset being transferred holds a different tax basis which affects the net amount of cash the seller receives after filing his federal and state tax returns. Don’t try this at home!
Enterprise Value
When public companies are compared in acquisitions, sophisticated Investors use a financial measurement called Enterprise Value to compare companies with different capital or debt structures.
Enterprise Value is a measurement of how much it takes to buy the entire company, not just the stock or equity. A company may sell its shares of common and preferred stock to investors for a sum of ‘X”, and at the same time assume the debt or liabilities equal to ‘Y’ and enjoy the cash on its balance sheet equal to ‘Z’.
Enterprise Value considers all three factors: Stock Price (X); plus the debt or liabilities on the books (Y); less the cash on the books (Z). EV = X + Y – Z.
Enterprise Value is a more accurate measurement of a company’s value because it includes the debt that the business must pay to its creditors and also accounts for the offsetting cash on its books.
Debt Counts No Matter What the Size or Kind of Business Sale
Business buyers, who understand capital structure and how a company’s debt negatively impacts its value, incorporate debt into the amount they offer to the seller. This is true whether the transaction is a stock or an asset sale.
If it is a stock sale, the buyer has added the amount of debt owed and subtracted the cash on the books to compute the company’s value.
If it is an asset sale, the debt is accounted for.
However, it is not a straightforward computation and the debt’s impact on the cash they ultimately receive from the sale is not always obvious to the seller.
When selling a business, the entrepreneur will be well-served if he seeks advisors who are able to provide apple-to-apple comparisons while accounting for debt and other liabilities. Although the computations needed to do so are not as simple as calculating the Enterprise Value of a public company, the principle is the same.
I sell for $50K a small company via a stock purchase agreement. There is a credit line of $35K assumed by the buyer of the company that has been used to finance working capital. When I pay IRS capital gains on $50K do I also pay taxes on $35K? Thanks
Hi George,
Not if the transaction was a stock sale.
The capital gains tax is determined by your tax basis of the company’s stock.
Congrats on the sale!
My business got into trouble and I had to borrow allot of money in future sale loans. Now the country is closed down and I can’t pay them. Can I sell just the assets of the business and file personal bankruptcy to be clear of the debt?
Would the debt go back to the business if I do this?
Hi Andy,
I am sorry you’re in this situation.
Your options at this point truly depend on how the business assets are titled and how the loans were guaranteed.
It’s best for you to consult with an Attorney who can help you navigate what’s best.
Here’s where you may request additional help.
Hope all turns out well for you.
Hi, I purchased Retail business a year before and sold in a big loss. For example, I purchased for $120K and sold for $70K. Can I show my business losses in taxes since I sold the business in a big loss? How can I do that?
Hi, Paul:
There’s some potential subtleties in your question, so I can’t answer to all issues without knowing a lot more detail, but in a nutshell, when you purchase a business asset or entity and then sell it, you have a CAPITAL gain or loss. This is different than an OPERATING gain or loss which is determined by the profit (or loss) from actually operating the business.
Yes, a capital loss is deductible on your taxes. But the loss is limited by any capital gains in the same year plus an additional $3,000. In other words, using your example, if you lost $50K on the deal and you made $10K profit selling stocks in the market in the same year, you would be able to take $10K profit minus $10K of losses (offset each other), plus count another $3,000 loss against your other income for the year. The remaining $37K loss is carried-forward to the following year.
If you have questions about taxes or this transaction, you can contact us or your tax accountant directly for assistance.
Hello!
I am a part of a family business that is going through a transition. The business is transitioning from a multi-member LLC to single-member LLC ownership as other family members leave and move on to other endeavors. The single member has agreed to take on all debts, but does this free the liability of the other members (we know it does not when they have personally signed the debt as a guarantor). What happens to state incurred tax debt if something were to happen to the business?
Also, if the business helped to pay for a renovation of a business office space inside a personal home of the family (not the owner member) does the house become a liability if something happens to the business?
Hi Noah,
If the LLC has liabilities, especially tax-related liabilities, the former LLC members may not be off the hook just because they no longer own the business.
They should consult with an attorney who is well-versed in corp and tax law to completely understand their personal responsibility for potential and/or ongoing liabilities.
As for the second question about the house becoming a liability, I am sorry I don’t understand what you are asking.
If you do not have legal or tax counsel, here’s where you may request further assistance.All the best…
I am trying to sell my small business ($4-5M in annual sales) originally planning it as an asset sale. The buyer’s bank is insisting on going through the SBA to get the loan. Although I have valuations at my price that the buyer has agreed to, the SBA is valuing the business at $500,000 below the agreed upon price. The bulk of that price difference is due to a “marketability adjustment” of 32%. We disagree with the adjustment for several reasons, but are trying to think of some ways to make this work for us and the buyer.
I believe the buyer would agree to a stock sale, which would save us approximately $33,000 in taxes and allow us to reduce the asking price. Are there other things that we should take into consideration before deciding on making this a stock sale rather than an asset sale?
We are considering self financing a portion of the difference, but really don’t want to absorb it all. Do you have other ideas that might allow us to close this sale?
I bought a business Sept of 2018. I just received a call from a collection company stating that my business was used as collateral by the previous owner in a loan that he has stopped paying. I looked and re-looked over my purchase agreements and there is no mention of any debt. They are telling me that I bought the previous owners debt. What are my options?
Hi Lee,
Very sorry for you to be in this situation.
Whether you will be held responsible for the former owner’s debt has a lot to do with the agreement you signed when you bought the business.
When signing an Asset Purchase Agreement, the assets and liabilities you were buying and assuming should have been clearly spelled out.
When signing a Stock Purchase Agreement, it is assumed that the buyer is responsible for all debts of the business.
Here’s a post on this topic which may be helpful to you.
As Randall stated, it’s likely you will need legal counsel to resolve the problem. If you don’t have an Attorney to assist you, here’s where you may request further assistance.
All the best…
Hello Lee:
You have found a hidden liability. It sounds like the lender may have a lien on your business assets and/or a UCC Filing (Uniform Commercial Code) may have been filed. A record of the lien can usually be found in the county clerk’s office and UCC filings are public records, usually at the state level (but can be found on a national search).
You’ll probably need to find someone to first verify if, indeed, there is an active filing on your assets, and if so, you’ll definitely want an attorney to both help get you out of this situation and perhaps get made whole from the seller.
Hi, my name is Beth, I am currently working as a manager at a restaurant and the owners are wanting to sell, and I am wanting to buy. If I own 10% of the company, how does the buying process work, and will I have to assume their debt?
Also, Can the business be renamed after the sale is made, and how do you value used equipment a year old?
Thanks so much,
Beth
Beth,
I am an Business Broker adviser with EXIT Promise and one of my specialties is the food service industry. Just to add to Randall’s comments, I have found that most restaurant equipment on average declines in resale value by about 20% per year. You also have to consider the wear and tear on the equipment, how well it has been maintained and life expectancy of the assets. For my clients, we have been able in most cases to accurately value unusual assets by searching the web for similar assets that are on the market. Used restaurant equipment is often sold and sometimes items are sold at public auctions. There is good public information on the value of used restaurant equipment. As another option, you could have a machinery and equipment appraiser value the assets. And, if you and the majority owners have difficulty in coming to terms on the value of the business, you could have a business appraiser value the business. The appraiser would factor into the valuation if some or all of the debt is included. Sometimes in any industry, majority and minority owners in a business sale have difficulty agreeing on the sale price and terms. The good news is the third party resources are available if needed to get a deal done. Specialty Business Brokers in the food service industry can be found in every area of the country, and they can help manage the entire process and determine if other third party resources are needed.
I hope this helps.
Greg Younts
Hi there Beth!
When you buy a company, EVERYTHING is negotiable! The buyer and seller make the rules (within the law).
When you are purchasing a share of an existing company, you are purchasing a share of everything…assets (furniture, bank accounts, food) AND liabilities (loans, debts, etc.). It doesn’t get separated from the business. Of course, you might negotiate that the seller will pay off some (or all) of the debt before they sell it to you.
If you purchase 100% of the company, then you can fully negotiate what debts stay with the business and what are assumed by the seller.
Once you own the business, you can certainly choose to rename the business. But caution: changing too much of a business may also cause customers not to return if they think that it is not the same business (or vice versa).
Valuing the business or its assets is as much an “art form” as it is an accounting function. Most equipment has at least two different values — the value on the books (in the accounting records) and the value for resale. Often, these are not the same.
If this business represents a large portion of your net worth or savings, it may very well be worth the cost of hiring one or more professionals to help you with this transaction. Just because an advisor costs a few hundred or few thousand dollars, doesn’t mean you’ll save more by not hiring that expert! An accountant or other M&A pro may save you many times their cost in the end!
Several years ago I agreed to be the guarantor on my company’s credit line. This was a really dumb thing to do. I resigned from the company three years ago, and only earlier this year did I come to realize that even though I was no longer an employee, my obligation as guarantor was still a thing. The latest development is that the company was sold just a few weeks ago. Does this sale automatically relieve me from obligation for the debt? I’m thinking it must, because I agreed to be the guarantor of Company A’s credit line, but never agreed to be the guarantor of Company B’s credit line. Any assurance you can offer would be happily received.
Hi Julia,
The sale of the business does NOT relieve you of the obligation unless the sales proceeds paid off the loan and closed the line of credit. If the new business assumed the debt, you wouldn’t be removed as a personal guarantor unless the bank specifically released you.
My advice would be to find out if the sale proceeds paid down the debt. If they did, I’d call the the bank and request the line of credit be closed so it can’t be borrowed on going forward.
If it turns out that the new business owner took over the loan, you will want to find out if the bank would be willing to release you from your personal guarantee.
Good luck!
I inherited my father’s retail business and am in the process of selling it as an asset sale. We have done a valuation based on assets vs liabilities. But if we as the sellers are going to be paying off the liabilities at closing, shouldn’t we do the valuation as having 0 Liabilities? Since the new buyer will not have any liabilities? I understand they would be included if it were a stock sale because the buyer would be responsible for paying them.
Also, how do you account for intangible assets like brand and customer loyalty, employees, website, reputation? Our business has been around for 30 years and is well known in our community.
Megan,
I am a Business Broker adviser for EXIT Promise and have had several engagements in which a valuation was performed by a qualified business appraiser to determine the value of the business in an asset sale or a stock sale. The qualified appraiser provides an in-depth report and can explain their methods and conclusion of value. Your appraiser should be able to explain to you if and why liabilities were factored into your valuation.
Also, the conclusion of value should show the total value of the business and percentage of the total value that is the Intangible/Goodwill value of the business. Appraisers often use multiple methods and consider several financial and non-financial aspects of the business to arrive at this conclusion of value. Appraisers conduct an analysis of several major aspects of a business that can include critical areas such as financial performance, milestones in the history of a business, competitive strengths and weaknesses, value of tangible assets, sales, marketing, operations, organizational structure, employee and management profiles, customer profiles, R&D efforts, future growth plans, a business forecast, etc… Your appraiser should be able to explain how they accounted for the intangibles in your business.
I hope this helps.
Hi ,I am exiting a partnership retail business with $40,000 in business debt.
My partner wants to continue running the business.
Is the actual business still worth money?The business is only on its second year and most of the debt is stock.
I know I am responsible for 50% of the debt but should my buy out be lower considering he is keeping the actual business ,name ,stock, contacts ect…?
Thank you for your time.
Hi Scott,
First, I think we need to make sure we’re getting out terminology straight. Stock (also known as equity) and debt are NOT the same thing. Debt typically means the funds need to be repaid to the lender. Funds from stock, on the other hand, do not need to be repaid. Instead, the person who contributed the funds typically gets an ownership stake in the business.
For the purposes of my response, I’ll assume you have debt. If you do have debt, you should not assume that you are only liable for 50% of it. Just because you are a 50% owner of the business doesn’t automatically mean you are only liable for 50% of the debt. You should check your loan documents, but in my experience with small business debt, the majority of personal guarantees are unlimited. This means you are both responsible for 100% of the debt. That would mean if you can afford to repay 100%, and your partner can’t afford to pay anything, the bank would expect that (and vice versa).
Finally, as to whether $40K is the right price, that depends. There a number of ways to value a business. It could be simply based on the value of the assets less any debt. It could also be based on prior sales of comparable businesses. If you speak with a business broker, they can probably give you some idea of the business value.
Good luck!
Hello, Scott.
The value of a business may not always be evident nor reflected in book value. For example, a business might take on debt in the short-run to acquire a very profitable long-term client. The opposite is true, too–a positive bank balance may not show impending doom of a crashing market segment. Because your question does not provide much information, we cannot determine whether the price offered to you is “worth the money”. More factors are involved than just the current situation of the “business being in debt.” Book value (what the books and records show) and market value of a business are almost always different numbers.
If you are not certain what your business is worth, you may want to speak with an accounting or valuation professional.