The Seller Will Pay Off the Company’s Long-term Loans
If a lender has filed a UCC lien against your business and you are now thinking about selling, the real question is what happens to the debt behind that lien once a buyer comes along. In the sale of most small to midsize businesses, the seller will pay off the company’s long-term loans at the time of closing (for example, loans secured by the business’s real estate, vehicles and equipment, and other loans it has taken out through the company). These loans are usually repaid from the sales proceeds, and then the assets are conveyed to the buyer free and clear. This will reduce the seller’s proceeds from the sale, which is something to be aware of.
Business owners often expect that a buyer will take over the loans because the buyer will benefit from the real estate, vehicles and equipment being paid off. That sounds fair at first glance, but it leaves out the factor of how the business was valued. There are these things called “add-backs” in business valuations that let buyers see the real advantage of owning a business. An add-back for interest on business loans is needed because the valuation assumes that at closing the seller pays off all loans. Adding back the interest means earnings go up. And the same interest gets added back when brokers use comparable sales to calculate the earnings multiple for the business, so to get an accurate valuation the seller’s interest has to be added back in, too. This is why business valuations assume all assets transfer free and clear - if you decide to transfer loans to the buyer, then the value of those loans will be subtracted from the purchase price.
For an owner who is already behind, this is where the math can turn ugly. If the loans and advances against the business are large, the payoff at closing could eat all your proceeds. That is the point where a business debt settlement company like ours steps in. At Delancey Street, our senior advisors negotiate with funders and lenders for less than the full balance owed, and we do not sell you another loan.
Transferred from Seller to Buyer
Sometimes debt is shared or even transferred from seller to buyer. For example, one business purchased equipment through a loan shortly before it went on the market. The seller had not yet taken delivery when the purchase agreement was written, but decided to keep the equipment because the buyer would need it to grow and the seller would need it if the deal fell through. The agreement was made and the buyer agreed to assume the loan payment. On a separate acquisition, the seller had an expensive piece of equipment that needed to be repaired or replaced imminently. The seller had no intention of shorting the buyer on an inoperable asset, and the buyer knew that the seller had no interest in spending money to buy new equipment for the business right before selling the business. They resolved to split the cost of a replacement as part of closing. Shared benefit is often the catalyst for these deals, but they’re not particularly common.
You might be surprised to find that not all of your debt can be assigned. Some loans contain “anti-assignment” clauses that can prevent the loan from being transferred to a third party. Loans may also contain “negative covenants” restricting major changes, such as a change in ownership, unless the lender approves or the loan is paid off. Either way, the lender will have to agree to the transfer, or you will have to pay off the loan when the sale happens.
What about a stock sale? It’s a common mistake to think that when you sell a company’s stock, the buyer is going to pay the company’s debts. Sure, that can happen when you’re selling a company for over $50 million, but in most smaller stock sales the seller still pays off long-term debt at closing.
Seller Net
Being realistic and knowing you will likely be responsible for paying off debts gives a clear picture of seller net, how much you actually take home, and may save you from discovering the truth only at the eleventh hour. If you are weighing a sale against a stack of debt, a first consultation with us is free and confidential. If a cheaper option exists, or bankruptcy counsel such as Subchapter V is the better path, we will tell you so on the first call.
