In our industry of small business sales, most businesses are sold cash-free and debt-free. This is very different to the way large corporations and companies are bought and sold, so it is important for both buyers and sellers to understand how it all works when buying or selling a small business. Here we will break it all down and explain what we mean by cash-free and debt-free.
Cash-Free In Small Business Sales
In small business sales, the seller keeps all of the cash on hand and money in the bank. None of that would be included with a sale. Also, according to the standard Asset Purchase Contract we use in Florida, all deposits on rent or utilities that the seller has paid will be retained by the seller. The buyer will have to make their own security deposit to the landlord or deposits to activate utility or vendor accounts. Furthermore, 99.9% of the time, in a small business sale, accounts receivable is not included in the sale and remains property of the seller, even when those payments come in after the closing. The buyer is obligated by the Asset Purchase Contract to deliver funds earned by the seller prior to closing. Many invoices are paid 30 days out or 45 days after service, so it could be a few months before those payments are mailed out, even though they have been invoiced by the seller before the closing date. Now, any pre-payments for service contracts or deposits already paid for future jobs would be credited to the buyer as “Work In Progress” and is entirely different from accounts receivable. Those amounts would be determined by buyer and seller prior to closing and would normally result in an adjustment to the final purchase price.
How Working Capital is Handled in a Cash-Free Acquisition
A common question raised by buyers is that of working capital. If the business is being sold cash-free, with no cash or accounts receivable included, how is the operation of the business funded on day one? That is entirely up to the buyer. In the case of an all-cash transaction, the buyer would simply need to make sure that they have enough cash on hand after the purchase of the business to fund the running of the business until they have generated the sales revenue to cover it. The beauty with purchasing an existing business is that revenue should be coming in on day one, so it shouldn’t take too long for the business to be covering its own expenses and the initial working capital investment can be paid back.
Alternatively, if the buyer is taking out an SBA loan to purchase the business, a line of credit or a certain amount is given to the buyer exclusively for working capital. This is very common, as lenders want to ensure that their borrowers have the best chance to succeed with their new business. It is in the best interest of all involved that the buyer is successful, so help with working capital is seen as a necessary item.
Debt-Free In Small Business Sales
As it sounds, debt-free means that the business will be sold without debts or liabilities. In the Asset Purchase Contract, in Section 8, “Seller’s Representations,” it states that:
"8.1 Seller represents to Buyer that all outstanding liabilities of the Business, except as specifically set forth herein, shall be paid in full by Seller on or before the Closing, and that Buyer shall receive possession of the Assets free and clear of any encumbrances other than any security interest that may be created pursuant to this Contract."
Also, in Section 21, “Seller’s Indemnification and Buyer’s Right of Set-Off” it reiterates that the business is being sold debt-free and it also outlines what happens if any unexpected debts do come in after the closing. In deals where there is no seller finance, usually a negotiated amount is held back from the seller’s proceeds for a agreed upon period of time (Escrow Holdback), just to cover the buyer, should any unexpected debts owed by the seller come in that the seller refuses to pay for.
"21.1 Seller indemnifies Buyer and shall hold Buyer harmless from all debts, claims, actions, losses, damages and attorney's fees, existing or that may arise from or be related to Seller's past operation and ownership of the Business, except for any liabilities specifically assumed by Buyer hereunder."
The buyer can assume certain liabilities of the business if they wish to do so, assuming the debts are assumable by a new owner, such as continuing with payments on equipment leases, for example. Other than that, the seller will be responsible for paying off any debts or liens on equipment at closing. The closing attorney will do searches for liens, publicly recorded debts, or outstanding taxes, and should the seller owe on any of those items, then the best practice is for the seller to let the closing attorney handle the payoffs of those debts at closing. They will order estoppels and they have certain procedures to follow to make sure everything is paid off and liens are properly removed. Should a seller pay off debts during the closing process, without consulting with their closing attorney, it could delay the closing, because it does take time to have liens removed. So, our best piece of advice to sellers is to communicate with your closing attorney regarding any debts, before taking any action to pay them off.
One extra layer of protection for a buyer when purchasing an existing business is that they will not be purchasing the stock or shares of the selling business's entity. The business entity will not be part of the sale, and it will be dissolved by the seller after the closing. The buyer is purchasing the assets of the business in their own business entity. It can either be an existing Florida LLC or Inc that a buyer has, or it can be a new one that the buyer sets up for this specific business purchase. Since the buyer isn’t purchasing the seller’s business entity, and they are simply purchasing all of the tangible and intangible assets of the business, the buyer gets to start fresh with a new business entity.