Selling a Business with Debt: Is it Possible? Yes But…

April 10, 2019

Oftentimes, business owners do not think about the liability side of the business sale. What happens to your business debt when you sell your company? Will the buyers assume the debt? Will you use proceeds from the sale to pay off the debt? What if your debt scares away potential buyers? If you are preparing to sell your business within the next five or ten years, any existing debt or any new debt you take on is going to create risk in your company. An increase in risk can lead to a decrease in business value. So before you finance another piece of equipment or before you utilize a business line of credit, decide whether the increased risk is worth the potential decrease in value to your business.

Perform a Debt Assessment

Before you can consider how your business debt will be paid upon the sale of your business, you must first analyze the state of your current debt. Essentially, you must perform a risk assessment on the debt. To do that, you can ask yourself some or all of the following questions:

How many more months or years remain on existing loans payable?
Are the loans, lines of credit, or credit cards in your business’s name or in your name?
Do you have any liens against your business or its assets?
Do you owe more on equipment than the equipment is currently worth (are you upside-down on any of the loans)?
Is your debt exorbitant or unreasonably high?
Will the amount of debt you owe scare off potential buyers?
Have you used credit cards to make purchases you could not afford otherwise?
Does your debt indicate that your company’s revenue is not high enough to cover business expenses, or does it indicate that you have been a poor steward of the revenue your company has earned?
Can you afford to pay off the debt without selling your business or its assets?
Do customers or tenants owe debts to you?

Your answers to these questions can help you determine whether or not you are ready to sell your business. If you are uncertain what your business’s debt looks like to potential buyers, you can pull a business credit and debt report through Dun and Bradstreet.

The Biggest Problem You’ll Face When Selling a Business With Debt

Whether you realize it or not, debt affects the value of your business. It really does. When appraisers, brokers, and buyers are determining your business’s value, one of the many equations they will use is the Enterprise Value Calculation. That equation looks like this:

Stock Price + Debts – Cash = Enterprise Value

Business buyers who fully understand capital structure and how debt negatively impacts business value will incorporate debt into the amount they offer the seller. And usually, the more debt you have, the less they will offer you for your business.

You see, the higher your debt, the higher risk your business carries because you MUST make enough revenue to pay for that debt in addition to your current expenses. That puts stress and strain on your business and increases its liabilities. Excessive liabilities can indicate a lack of business profitability. As a result, buyers may be reticent to purchase your business, or they may take one look at your debt and walk away from buying your business. After all, who wants to assume debt on inventory purchases you made three years ago or on equipment that’s ten years old? Therefore, you must know what you intend to do with your debt if you are planning to sell your business.

Options for the Debt When Selling

So what are your options? What can you do with debt when you sell a business?

Pay-off debt before you sell. – If you are “drowning in debt,” then you may need to reduce your debts before you attempt to sell the company. Make sure there are no liens on the equipment you are including in an asset sale, and make sure you are not paying any personal loans through your business. Buyers will not want to assume either of those debts.
Pay-off debt with the proceeds from the sale. – If do not have extra revenue or cash on hand to pay off debt before you sell your business, buyers may include a debt pay-off contingency within the purchase agreement for your company. They may require you to use the proceeds from your sale to pay-off many or all business debts so they do not have to worry about liens on the equipment they are purchasing.
Have the buyers assume the debts. – If your debt is limited to loans on equipment, machinery, inventory, or anything else your business needs to operate, buyers may agree to assume the debt when they purchase your company. However, oftentimes, you are the personal guarantor of the loans. Therefore, the assignment cannot or may not be transferred to the business buyer. So just because you have debts on equipment or inventory, you cannot assume buyers will want to or be able to assume the debt.

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Ultimately, company debt affects the sellability of your business. So if you are thinking about selling your business in the next five or ten years, you must consider the risk involved with taking on new debt or more debt. If you are trying to grow the value of your company, then you want to decrease risk. To decrease risk, you need to pay off your business debts. It’s not safe to believe a buyer will assume your debts or that your lenders will let someone else assume your debts. Instead, you need to work on reducing or eliminating your business debts before you sell your company.