You sold the business and moved on. So why is a funder or a lender asking you about money the old company owes? It’s a fair question - and you’re not alone in asking it. When a company is sold, who owes the debt afterward can be very clear, or it can be a complete mystery. The answer depends primarily on the structure of the sale. As we’ll show, the legal structure of the transaction has a great deal to do with who pays the bills. What type of deal did you sign?
Stock Sale
In a stock sale, the buyer buys the stock of the entity that owes the debt (or if it’s an LLC, the “membership interests”). As part of the transaction, the seller gives the stock certificates to the buyer, and everything the entity owns and owes transfers to the buyer. The debt was, after all, legally incurred by the company, not the owner. So after a stock sale, the buyer inherits all the assets and liabilities of the company. When the deal closes, the buyer owns 100% of the company, and that company retains all its assets, debts, contracts, and any other rights and obligations. For good or ill, the buyer inherited the seller’s company and all that it came with, including the debt. A stock sale is considered the easier method, because there is no need to individually list all assets and liabilities of the company.
This type of deal is very rare for businesses with less than $10 million in value. By one estimate, it is less than 5%. The main reason a buyer would want a stock sale is if they want something the entity owns that can’t be transferred separately in an asset sale, like a lease, or a contract.
Even so, a stock sale does not always get the debt off your plate. There are three exceptions in a stock sale where the debt stays with the seller. The first is debt that the seller owes as an individual, unless they separately assign it to the buyer. The second is when the buyer tells the seller to pay the debt at closing. The third is when the seller agrees to be responsible for the debt even though the entity may be legally responsible for it, such as a lawsuit.
The Buyer Purchase Only the Assets of the Business
The more common way to structure the sale of a business is to have the buyer purchase only the assets of the business. This is the overwhelming majority of sales of companies under $10 million. The buyer and seller negotiate which assets and liabilities transfer and which don’t. Most often, they include all of the assets necessary to operate the business, but none of the liabilities. Usually the buyer creates a new entity to take over the assets. The reason for an asset sale is often that the buyers don’t want contingent or unknown liabilities (that is, they don’t know what the amount is, as with a lawsuit or product liability).
That is where the seller can be left holding the bag. In an asset sale, the debts are usually excluded, unless the buyer agrees to take them on. The truth is that not all debt is transferred with the sale of a company. Whatever the buyer did not take on stays behind with the seller’s company.
One more wrinkle: If the equipment was leased by an individual, the lease has to be transferred separately in a stock sale or an asset sale.
Then there is successor liability. This is where a state law may allow the creditor to recover from the buyer even in an asset sale and even though the buyer didn’t agree to assume the debt. The most common types of successor liability are product liability, environmental, employment, and certain types of taxes, like sales tax. It varies considerably from state to state. Bulk sale laws are in effect in some states (for example, California). Buyers perform due diligence and may escrow, or get an indemnification from the seller. Many “middle-market” transactions will have a hold back from the sale price. For you as the seller, the indemnification piece matters, because the purchase agreement may require you to cover the buyer if successor liability comes up.
There are three ways to handle the debt at closing. The first is to pay it off with cash before the close. The second is to have the buyer assume the debt. The third is to have it paid out of seller’s proceeds at closing through escrow. For example, if the company was sold for $10 million and it owed $2 million, $2 million would be deducted from the seller’s proceeds, so the seller would walk away with $8 million.
A Creditor Is Still Coming to You
So if you’re a former owner and a creditor is still coming to you, the first step is to figure out how you sold the business. Was it a stock sale or an asset sale? And if there was a purchase agreement, what did it say? The devil is in the contract.
If the debt did stay with you, you still have options. At Delancey Street, we are a business debt settlement company. Our debt advisors work with merchant cash advance funders, lenders and other business creditors to settle debt for less than the full amount owed. We do not sell a loan to a borrower, and we are not a law firm. In the event that litigation or bankruptcy would be the best option for our client, we refer him or her to an independent attorney. Our first consultation with a client is free and confidential. If we know there’s a less expensive option, we’ll tell you about it on the first call.
