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 have question about a small company named on my wife, that is operating a convenient store on lease. I wanted to float another company on my name but not on my wife in place of the old company. I will terminate the lease agreement with old company and initiate agreement with new company. What will happened to the assets or liability of the old LLC that will pass on to new company? or that will stay with old company. Thanks
Hi Ajaib,
When you have a business entity, such as an LLC, and you choose to close it, the assets and liabilities must be settled by either transferring them to a new business owner or winding down the entity. The state in which your business entity had been formed has a formal process to transfer the assets or to dissolve a business which should be followed.
Hi Holly!
We bought a franchise and ran it successfully for 18 months, with more than fantastic results ($3MM+ in monthly revenue) until our franchise agreement -and everyone elses- got abruptly interrupted.
We signed a confidential agreement stating they were not succesors of the business nor were they buying it. But the truth of the matter is they are using the same locations, the same name, the same assets and even most of the same people.
A big amount of the settlement agreement is still being held in escrow -after a year- pending we present all documents from BOE (CA) and other taxing authorities issue tax clearance certificates. But such certificates are only issued when a business is sold. To get these, the buyer, stating he is the buyer to such authorities, requested such documents. And though we have presented a dozen documents, they keep finding excuses not to release the money.
In the meantime, I started a new company under the same activity (we are actually neighbours now), and the non release of funds is hurting my new business.
Though I hold no debts with taxing authorities, I do have a debt from AP from the old company. I am planning on ‘buying’ such credits with my new company, since they are still my vendors for the new company.
Can my new company, as a credit holder of my old company -by means of buying all pending AP-, go after my former franchisor now that they have aknowledge in writting severl times they are in fact the succesors of the business?
Thanking you in advanced,
Hi Paul,
I truly wish I could answer your question. Unfortunately, it’s clear you have several situations at play — franchise acquisition, franchise successor, settlement agreement, escrow agreement, tax clearance issues, new business startup, and creditor issues.
The best source to answer your question (and to assist you in resolving the matters you’ve described) would be an Attorney licensed in your state who handles corporation, franchise and M&A law.
We are considering acquiring a small business that has a sizeable amount of accounts payable. After the purchase, as we make payments on the payables, are we able to deduct/expense those payments? Is there any tax advantage to assuming the payables?
Hi Shannyn,
If you purchase a business (either as a stock purchase or as an asset purchase with an assumption of Accounts Payable), as the buyer you would not be able to deduct payments made to the vendors for A/P for products/services recorded before the closing. The seller would have deducted those expenses already.
There are many tax consequences to both the business buyer and the seller. It’s important to understand the differences between buying a business under a stock vs. asset method. I linked out to a post on this subject (above) for you to read more about it. All the best to you in your acquisition…
Good afternoon
Interesting scenario:
Small corporation, less than 20 employees
3M in bank debt, 10M in inventory, approx 6-7M annual revenue. One primary owner (few small stock holders).
Run away or buy? If so what is the best method?
Hi Samantha,
The facts you’ve shared with us are important, however they represent a small portion of what needs to be considered when buying a business.
You should be looking at revenue trends, gross and net profit margins, its customers and customer concentration, industry trends, its contracts, and a few more dozen important factors before proceeding to purchase a business.
I am sorry I am not able to offer you specific advice with regard to whether to buy this business and how to structure it in our Q&A forum.
I agree it’s an interesting opportunity… be sure to do your homework!
Hi Holly –
I’m trying to help a friend who was working for a company for almost a year and never got paid for the work she did, essentially doing their distribution for Northern California for their products. The company was sold and she has been now working for that company since January. Is the company that purchased the old company still responsible for paying her what is owed before their purchase? They are trying to tell her that they are not. She has all of the documents showing what she should have been paid up to this point and they have all the records of the books showing the matching information. She is a quiet person so she hasn’t really pushed it with them but, I think it might be time she should if she has a leg to stand on.
Thank you for any advise you can give.
Hi Jessica,
I am sorry your friend is having troubles!
The answer to your question depends on whether the business in question was sold as a stock or asset sale. In a stock sale, the new owners are generally responsible for all of the liabilities of the business before and after the sale. There may be certain liabilities in a stock sale which are carved out and attributable to the seller after the sale. This is accomplished through an indemnification clause and isn’t common.
In an asset sale, the new owners may be responsible for the liabilities of the business before the sale. It depends on how the asset purchase agreement was drafted.
For an outsider, such as your friend, it’s difficult to know the details of the transaction. Just asking if the sale was an asset sale or a stock sale may give your friend a clue about whether the debt is the responsibility of the seller or buyer.
If the sale was an asset sale and this debt was not one of the liabilities assumed by the new owner, then the seller should be held responsible. The seller in an asset sale transaction cannot just walk away from the business’ debts which are not assumed in the sale by the buyer.
I hope this helps!
I sold my 50% share in a business partnership to my partner in April. We had two entities together, business and property holding company. I sold my half of each to the partner and exited. There was $180k of debt on the property and my personal accounting is stating that my half of that debt ($90k) will now be viewed as income to me in addition to the sale price because I’ve been released from the debt. This doesn’t seem correct – thoughts?
Hi Mariah,
When you have two partners in a partnership and one sells his/her portion to the other, essentially the partnership dissolves. You can only have a partnership when there is more than one partner.
What’s happening is a liquidation of the partnership and your pro-rata share of the partnership’s debt forgiveness becomes income to you unless you pay off the loan.
I am sorry I don’t have good news for you Mariah…
We had a business which started in 2013 and was sold in 2015, we did register for COIDA at the end of 2014
with no feedback received of any outstanding amounts.
The business was sold in 2015 and now we are told that there are outstanding amounts ….who is
liable for this cost? Are we still responsible as we have no business or the current owner?
Hi Jason,
The COIDA is related to occupational liabilities in South Africa which I am not familiar with.
That said, I’d suggest you look at the purchase agreement which you and the buyer signed when you sold your business to determine how liabilities (on the books and those which are not) should be handled after the closing. You also may want to look at the indemnification clauses in your purchase agreement. Doing so may offer you a good place to start to determine your next steps.
I am considering buying a business that has SBA debt that can be assumable by the new owner. If the prior owner had to pledge assets and a personal guarantee, would I have to do the same? Will SBA require any specific terms or conditions on the sale of the business outside of the new owner owning the debt?
Hi CBT,
When a SBA (Small Business Administration) loan is in place, it’s important to understand that the SBA did not lend money to the business. Instead, a bank did and the SBA stands behind the business borrower as a guarantor if the loan should go into default status. Often people think the government is lending the money when a SBA loan is made. This is not so.
Accordingly, there is a bank involved with the loan and the business you are considering. The business owner should provide you with a copy of the bank loan agreement and the SBA Guarantee documents associate with the business loan. That’s where you will be able to find the conditions (if any) in which another person may assume the loan.
Generally speaking, a bank and the SBA requires business owners to provide funds (a down payment) and pledge personal assets when they lend money to a business.
Good luck with your business purchase!
I own a small business am wanting to semi retire there is not a lot of debt out it has been a sole propertship if I sold to him for so much a month would the degt follow me which ja what I want
Hi Ron,
As a sole proprietor the only option you have when you sell your business is to use the ‘Asset Sale’ method of sale.
What this means is that when you sell your sole proprietorship you are simply selling assets you own as a individual to another individual (or business entity). Typically debts related to a sole proprietorship remain with the seller when a sale occurs.
All of this should be spelled out clearing in your Asset Purchase Agreement so it is very clear what you are selling and whether any liabilities associated with your sole proprietorship are your responsibility or the new business owner’s responsibility after the sale.
I want to take over a company that has debt. It has very little assets. I understand if I buy it using the asset method I can limit my responsibility to the old debt. My question is, am I able to use the same business name and website and put it as a DBA under my current corporation? The business isn’t worth anything tangible at this point but they do get A LOT of phone calls from repeat customers and thru the website. I just do not want to change the name of the company and start from zero. Your advice? Thanks
Hi Zig,
Well, I am unable to advise you as to how to negotiate your acquisition. However, I am able to offer you information and best practices when your acquire a business in an ‘asset sale’.
When you buy a business under an asset purchase agreement, just as you’d spell out which liabilities or debts are to be assumed by the buyer, you will need to specify the assets being acquired as well. Some of the assets you may want to assume and spell out in your APA could be the business name, website domain name and hosting account, social media accounts, email list, site phone numbers, logos, taglines, customer list, etc. The intangible assets mentioned here may be recorded on the company’s balance sheet, however most will not.
As the buyer, being very clear in the Asset Purchase Agreement (APA) regarding exactly what you are acquiring (assets and liabilities) and what you are NOT acquiring is vitally important! Good luck to you Zig!