Business loan and credit providers prefer profitable companies with a strong multi-year operating history and strong cash flow. If the business does not fit this profile, lenders and large suppliers will want collateral. According to the National Foundation of Independent Business, property – residential and commercial, personal and business – is a significant collateral source for small business loans. When a business owner successfully sells a business, he will need to address any outstanding property liens.
Property as Collateral
Collateral is something pledged as security for a loan. For small businesses that have a minimal operating history, thin cash flow and/or few business assets like inventory or equipment, that collateral is often real property, or land and buildings. When a lender accepts a particular property as collateral, it places a lien on that property and records the lien with the county in which the property is located.
When selling a business, the best way to ensure you identify any and all existing business liens on a property is to do a title search. The buyers should do a title search to protect their interests. However, as the seller, you could be sued for not disclosing liens that a buyer later discovers on a property. With an asset sale, the new owner takes over all assets listed in the purchase agreement, wholly unencumbered except where explicitly stated otherwise. With a stock or membership interest sale, the new owners take over the entire company’s assets and liabilities, including any liens, unless explicitly excluded.
Asset Sale Example
If you own an office building in your name and placed a lien on the property to fund your company, and you sell the company and keep the office building, you would be personally responsible for a lien that remains on your building. If you sold the office building as part of the asset sale, then you would pay off the mortgage and the business lien at closing from the business sale proceeds.
Stock Sale Example
If your company owns a warehouse in its name, when you sell the stock, the buyer gets the warehouse. With this type of sale, the new owners assume all liabilities unless expressly stated to the contrary. The buyer will likely request you pay off the lien at closing. If he does not make the request, then the buyer is responsible for paying off the lien.
The best source of protection is to use the proceeds from the sale of the business to fully repay any loans in the business’ name. When you fully satisfy the loan terms, the lender must completely remove the property lien and provide you with written documentation. It is your typically your duty, per your Purchase Agreement, to check all county or municipality filings and documentation to ensure compliance. Occasionally, a bank forgets to remove a lien against a particular property. If they do, you must notify the bank to correct the errors immediately.
National Federation of Independent Business: Small Business, Credit Access, and a Lingering Recession p. 3, http://www.nfib.com/Portals/0/PDF/AllUsers/research/studies/small-business-credit-study-nfib-2012.pdf