Selling a Business That Has Debt: Loans, Leases and Liens

Plenty of small businesses are sold while they still owe money: a bank loan, a line of credit, a vehicle or equipment lease. That's normal, and it rarely stops a sale. What matters is knowing exactly what's owed, who holds a claim on what, and how it will all be paid out on closing day.

Start with a clear list of what the business owes

Before you talk price with anyone, write down every debt and obligation, with the lender, the balance, the monthly payment and any payout penalty:

• Term loans from a bank, credit union or BDC.
• Lines of credit and business credit cards.
• Equipment, vehicle and point-of-sale leases or financing.
• Shareholder loans you or family members have made to the company, or the company to you.
• Amounts owing to suppliers and any customer deposits you're holding.
• Taxes and remittances: GST/HST, PST, payroll source deductions and workers' compensation premiums.

Buyers will ask for this during due diligence, so having it ready makes you look organised and avoids surprises late in the deal.

Asset sale or share sale: who keeps the debt

How you sell changes what happens to the debt. Our guide to asset sale vs. share sale explains the two in full.

• Asset sale. The buyer buys the business's assets, not your company. Debts normally stay with you or your company, and you pay them out from the sale proceeds. The buyer will want every lien on the assets they're buying discharged at closing.
• Share sale. The buyer buys your company, and the company keeps its debts. The price is usually set on a "cash-free, debt-free" basis: the buyer agrees a value for the business, and the amount the company owes is taken off what you receive (and any cash in the bank is added). Some lenders also have a change-of-control clause that makes the loan due when the owners change.

How debt is usually paid out at closing

In most small business sales, the buyer's money comes in and the debts are paid out on the same day, through the lawyers' trust accounts. A typical flow looks like this:

1. Your lawyer asks each lender for a payout statement good to the closing date, including interest and any penalty.
2. The purchase price, less those payouts and any closing day adjustments, is set out in a statement of adjustments.
3. On closing, the lawyer pays each lender directly from the proceeds.
4. Each lender then discharges its security, and the remainder comes to you.

This means you don't need to find cash to clear the debt before you sell. It does mean the amount you walk away with is the price less what's owed, so do that sum early.

Liens and security interests

When a lender gives a business a loan or lease, it often registers a claim on business property, called a security interest or lien. It might cover one vehicle or piece of equipment, or "all present and after-acquired property" of the business. Each province keeps a public personal property registry, such as the Personal Property Registry in BC, and the buyer's lawyer will search it.

Search it yourself, or ask your lawyer to, before you list. Old registrations sometimes stay on the registry after a loan is paid off. Getting a lender to discharge an old one can take a few weeks, so it's better to find it before a buyer does.

Equipment leases and financing

Leased equipment belongs to the leasing company until the lease is finished. You can usually either pay out the lease at closing and include the equipment in the sale, or have the buyer take over the lease if the leasing company approves them. Ask each company for a payout figure and its transfer process. Our guide to transferring contracts, licences and permits covers leases and other agreements that need consent.

Personal guarantees

Many small business owners have personally guaranteed a loan, line of credit or the commercial lease. That guarantee usually stays in place until the debt is repaid or the lender or landlord releases you in writing. If the buyer is taking over a lease or loan, ask for a written release as part of the deal. If they won't release you, agree how long you'll stay on as guarantor and what protection you'll have. Our guide to your commercial lease when selling covers landlord guarantees.

Taxes and remittances owing

Unpaid GST/HST, PST and payroll source deductions are treated seriously, and in some cases directors can be held personally responsible for them. Buyers' lawyers will usually want to see that filings and remittances are up to date. Bring everything current before you list, or plan to pay what's owing at closing, and ask your accountant to confirm your final returns. Our guide to GST and PST when selling a business covers sales tax on the sale itself.

Shareholder loans

If you've lent money to your company, or taken money out of it, that balance usually needs to be settled as part of the sale. In a share sale it's often repaid to you at closing or built into the price. The tax treatment can matter, so ask your accountant how best to handle it.

Can the buyer take over a loan?

Sometimes, but only with the lender's agreement. The lender will assess the buyer like any new borrower. It's more common for the buyer to arrange their own financing and for your loans to be paid out. If you're offering part of the price as vendor take-back financing, remember that the buyer's bank may want its security to rank ahead of yours.

What to tell buyers

Be upfront. Debt isn't a reason for a buyer to walk away, but finding it late can be. Share a simple schedule of what's owed once the buyer has signed a confidentiality agreement, and be clear in your letter of intent about whether the price is debt-free. The purchase agreement will usually include a promise from you that the assets are free of liens other than those being paid out.

A practical checklist

1. List every loan, line of credit, lease, card balance, shareholder loan and tax amount owing.
2. Note the balance, payment, end date and any payout penalty for each.
3. Read each loan and lease for change-of-control or sale clauses.
4. Search the personal property registry and clear any old registrations.
5. Bring GST/HST, PST, payroll and workers' compensation filings up to date.
6. Work out what you'd receive after debts at your asking price.
7. Decide with your accountant whether an asset or share sale suits you better.
8. Before closing, have your lawyer get payout statements and arrange discharges.
9. Get written releases of any personal guarantees, or agree terms if they stay.

A note on advice

This guide is general information, not legal, tax or financial advice. Loan and lease terms vary a great deal, and so do the rules on taxes owing and personal liability. Please have your own lawyer and accountant review your debts and the purchase agreement before you sign.