Whether accumulated through bank loans, lines of credit, or credit cards, debt is a natural part of operating a business. Developing new products and services, hiring additional staff, opening new locations, and purchasing inventory are all common reasons why a company seeks debt-based funding.
This raises an interesting question: What happens when a business owner is ready to sell but still carries a significant debt load? Let’s take a closer look at how a sale works under these circumstances, and what business owners need to know before moving forward with an exit that includes debt on the books.
Selling a Company with Debt: The Basics
The first decision a business owner needs to make when pursuing a sale involving debt is simple: Should I pay off the debt and sell with a clean sheet, or include it as part of the transaction?
The former approach has some substantial benefits. Primarily, it will allow the seller to retain more cash at the closing because they won’t have to pay funds to deliver the assets free and clear of debt. Additionally, not having debt will simplify the transaction.
Of course, not every business generates the earnings to satisfy all creditors prior to a sale. Alternatively, the buyer may assume some or all of the debt as a part of the purchase price. In these situations, the seller will receive less cash at closing but won’t be obligated to pay off the debt. In either case, buyers will want to know why the target business has accumulated debt, and sellers need to have a reasonable and convincing answer to the question. It’s crucial to be straightforward and forthright when having this discussion.
Any owner considering a sale should understand and
inventory the type of debt the business and the owner holds and how restrictive
they might be to a sale.
- What type of debt does the business hold (loans, lines of credit, credit cards, etc.)?
- Is this debt held in the name of the company or the name of the owner?
- Are any of the loans shareholder loans that can be negotiated among the selling partners?
- What are the terms of the debt, and when will it be satisfied on the current payment schedule?
- Are there any lien holders? If so, what type of lien holders exist? (This may impact which lien holder is paid first.)
- Is any of the debt attached to real assets? If so, are any of these loans underwater?
- Is the overall debt load of the company too high, or is it reasonable? Is it likely to deter potential buyers?
- What is the story that’s told by the company’s debt (if it is too high)? Has ownership been financially irresponsible? Too ambitious in terms of growth? Or is revenue too weak to sustain operations?
- Can the business afford to pay the debt down?
Once this assessment is complete, business owners should have a clearer picture of the state of their debt situation. If debt loads are high and the reasons supporting that elevated debt indicate mismanagement or poor revenue, it may have a significant impact on the owner’s ability to sell the company. Debt, when used correctly, can fuel a company’s growth. However, when used unwisely, it can act as a brake on growth or even place incredible strain on an enterprise.
Having conducted this inventory, sellers will be in a better position to work with their advisors to determine how to accomplish the desired outcome in a transaction. If you’re seeking help selling a business with debt or closing a business sale of any type, please contact VR New Haven. As a top business broker in CT, we have the experience and expertise to help you close a sale in a timely – and profitable – fashion.