Can You Sell a Business with Debt?

Owning and growing a business takes a lot of work and capital. As a business owner, you may have used debt as part of your business operations and expansion. Debt is not inherently bad, and is often the best financial choice when considering the capital structure of a business. However, it is important to understand what happens to debt when you want to sell that business.

Yes, you can sell a business with debt

You should, however, understand how this may impact your valuation for the business if you were to sell it. When we structure transaction offer letters, we propose a valuation that is cash-free, debt-free. That means that the seller keeps the cash in the business and pays off the debt at close. This is true whether your sale is a stock sale or an asset sale. 

We do this because a business valuation should not be impacted by the way in which the current owner has decided to capitalize it. A company’s value is determined by its assets and its ability to generate cash flows. How the owner has chosen to finance these assets or earnings is irrelevant. 

This is also the reason why we chose EBITDA as a foundation for valuation, because it excludes interest (that’s the “I” in EBITDA). EBITDA is a proxy for the cash flows that a business produces without regard to how it is financed or the tax that it pays. When we multiply EBITDA by comparable transaction multiples, we are then able to compare apples to apples. 

For my nerdy readers, this theory is called the Modigliani-Miller theorem to business valuations and it has been around since the 1950s. 

Theorems aside, what does this mean for a business owner looking to sell? 

Because you will receive an offer that is “cash-free, debt-free,” you will most likely be required to pay off the company debt at or before closing. Usually, the debt payoff occurs during the wiring of the transaction proceeds, where the bank gets the first wire and pays off the balance and then the remainder goes to the owner. A business owner can pay off prior to a transaction, but it is not necessary to market the business and will not impact the proceeds.

The definition of debt during a sale transaction

Some of you might ask, “what is debt?”, which seems simple but can be tricky. When an offer is made, the buyer is expecting you to pay off bank debt, equipment loans, or mortgages. Think long-term liabilities on the balance sheet. Short-term liabilities that are not current maturities of long-term debt will be handled separately in working capital.

A buyer will not require you to pay off trade receivables. If an asset will not be used as part of the business going forward, it may be necessary to pay off. For instance, if an owner has a vehicle through the company that they wish to take with them, the buyer will expect that auto loan be paid at or before closing.

Is it always paid off when a business is sold?

In some rare circumstances, a buyer may assume the company’s debt. If for instance, a company has very low interest debt as a result of municipal financing or government programs, a buyer could assume that debt and save on getting their own (presumably high interest rate) financing. In many cases TIF Financing or program financing has a change of control provision, so a review of the relevant loan documents would be required. 

There are other very rare circumstances where a buyer and a seller may decide to transfer a company debt, but these are few and far between.

There are a lot of articles and blogs out on the internet that answer that a company’s debt can impact how potential buyers might view the business. Unless it has effectively bankrupt you – this is simply not true. I think both Modigliani and Miller would agree. You can sell a business that has debt, but you must be prepared to subtract that amount from the proceeds you receive.