Many small business owners took advantage of the EIDL and PPP programs to take out loans against their businesses. When you’re trying to keep your staff on board through an interminable series of open-close-open-close government mandates that keeps both staff and customers from coming in, the programs looked like a real lifeline. 

Better yet, the government hinted that under the right circumstances, the loans would be forgiven. Now that’s the definition of free money. 

Every small business owner knows how hard it is to raise capital at all. Corporate structures may protect you from lawsuits, but banks and government agencies require you to put your personal credit on the line and mostly they consider you to be overstretched and won’t lend you any money. When a program comes along that appears to be offering money at all, and free money at that, you have to take it seriously. And these programs made it very easy to do so – minimal documentation to get the money and very seldom any checks to see whether the business picture being portrayed was true. No oversight of what you did with it, as long as you started paying it back whenever the moratorium would be lifted– plus of course the possibility that you would not have to pay it back at all.

But any time you are dealing with a government program, you can be sure that behind the EZ application form, there’s a mountain of regulatory clauses, all of which basically says that you are the one responsible for anything that goes wrong, including them giving you a misleading impression from the start, or them changing their minds.

Now here we are in 2022. (Don’t worry if you’re reading this later when the COVID hullaballoo has subsided. This applies to any form of loan, not just those COVID era programs.) You’ve navigated the downturn and the last year or so has been better than ever. But the exhaustion! It’s time to think about letting somebody else take over the stresses of running a business, especially when a small business is still a sound investment relative to the market and investment dollars are easily available. 

What a great thing to achieve the goal you have worked towards for so many years, take a nice payout, and get a lot of stress relief! Closing day cannot come too soon.

But unless you and your business are properly prepared, that day may never come.
What the rest of this post relates is not hypothetical. I’ve seen it several times just this year. Learn from the mistakes of others.

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​When you sell your business (assuming the “asset sale” structure used by almost all businesses under $5 million or so), the buyer takes it “going forward”. You clear any debt you have accrued, and you get to keep the cash in the accounts, less reasonable working capital. Typically, you are also entitled to the pending receivables, although in many cases sellers walk away from those because tracking the collections is more hassle than it is worth. 

You have a nice lifestyle business (meaning you work in it directly, which is often a condition of a small business loan) that generates maybe $80,000 per year. That places its market price at between $160,000 and $240,000. Optimistically. But, because you are forward-thinking, you’ve done the things needed to get the best price for the business (which is what Business Value Booster is all about). Now you’re in a good position to ask $249,000, hoping to get near that after the negotiations are done.

You are going to be very busy keeping the business going, even though your staff is capable of running it without you for a few days at a time, because you know it is important for it to be at top speed throughout the sales process, as buyers need to see that revenue coming in. You decide to use a business broker to help you sell the business so you can keep focused on running it, and because you have no idea how to sell it or where to find a buyer. The broker’s commission will be somewhere in the $20,000 to $25,000 range on this deal. (You could decide to do it yourself, but your odds of success will drop dramatically. Try it for a while and see what happens – just don’t let the business fall off while that is going on). 

For half of that fee (the other half is going to the buyer’s broker), your broker will advise you on many matters and set up many actions for you. The broker is constrained by law not to provide definitive advice on legal or accounting matters. You are also going to need an attorney’s support, not nearly as much as the buyer but still you should have a lawyer review the contracts, prepare certain documents essential to the sale, and provide you advice through the process. You are also going to incur some costs from your accountant, producing the initial P&L reports used to generate your listing and disclosure documents as well as other reports that the buyer may require of you during due diligence. You should count on at least $5000 in fees between these two professionals. Yes, that $30,000 is a painful bite, but without it you will probably join the 80 percent of “for sale by owner businesses” that never sell and end up closing their doors and the owner never sees a dime.
 
Because of your sound management, the business accounts have another quarter million, and (after allowing for a month’s working capital) you can pull all that money out and take it home. (Having that kind of money on hand makes you one of a very small number of small businesses, but let’s enjoy the moment). 

Woo-hoo, with all that solid profit on display, you get an offer close to asking price.  Nearly a quarter of a million dollars! And because everything is so squeaky clean, the buyer won’t try and ratchet you down a bit during the sales process. And those liquid assets! You are looking forward to closing day and two nice fat cashier’s checks, one for $200,000 for the business and one for $200,000 from the accounts. What a pay day! Makes the years of sweat and struggle worthwhile.

But that day never comes.

Within days of making the offer, during the due diligence process, the buyer’s attorney or accountant discovers that there is a lien on the business. And not with a local community bank that might be persuaded to make some sort of accommodation. This loan is owed directly to the US Government.

In good faith at the time, you took out one of those free-money loans for maybe $200,000. Now we are in 2022, and any amnesty period has expired. That’s probably where that nice pile of cash in the company’s accounts came from. If you have that, or muck of the balance and you know where to get the rest, then you clean out your piggybank and pay the loan off. The bad news is that your hoarded cash disappears. The good news is that the long arm of Uncle Sam will be satisfied, and you will still wind up with $200K in your pocket. Sure, it is not $400k, but you won’t be in debt to the government. (Well, there may be capital gains tax owed, but that is a whole other discussion).

But what if you don’t have that cash anymore?

None of your options at this point are what you were hoping for. (By the way, these are just some options I’ve seen play out. Do not take these options as definitive. You need to explore the options that are open to you, in your situation, in your state, with an attorney):

• Pay off the loan from the proceeds of the sale. The settlement attorney (who is paid by the buyer) can make that happen so that the loan is satisfied. Of course, you end up with nothing at closing, but at least you have eliminated a major debt to the government, which has the means and the patience to collect it. If the closing balance doesn’t cover the loan, you’ll have to dig into your other assets to cover the difference.
• The buyer assumes the loan. This is your best option. Most of the loan programs have fairly flexible assumption terms, but they do require that they approve the buyer in advance of the sale. Of course, the buyer will take that out of the price they were going to pay initially, so it is similar to paying it off at closing, but it works out better for both parties. Why is it better? The payments are deferred over time and most buyers will prefer to take on some long-term debt instead of giving you all cash up front. You can end up with some cash at closing and the loan off your back.
• Keep running the business. This is the opposite of what you were thinking about, but you could withdraw from the sale and keep running the business until you can make enough money to pay off the loan (and hope that it may be forgiven in some other amnesty program). In theory you may have some contract termination costs if this all comes up as a last-minute surprise, but it’s more likely just to fall apart if it arises during due diligence. Since you can’t pay the loan, you won’t be able to pay any damages to the buyer, although you may end up with another lien on the business for several thousand more dollars.
• Not an option: keep the loan and keep making the payments. What a plan! $200k cash, $200k at closing, and just pay off a low-interest loan over time. After all, they made you take on personal responsibility for the loan too, and you’re going to pay it. So why not? Here’s why not: it’s called “fraud.” Unless you look good in orange, it’s a bad plan. Here’s the problem: the loan wasn’t made to you. It was made to the business; you just guaranteed it. It was predicated on having the assets of the business as collateral. Selling those assets would be to defraud the lien holder. Even if you fully intend to make the payments, it is still fraud. The settlement attorney is not going to accept conducting such a closing, or they too would become a party to the fraud, as would the buyer, now that they know about the lien. In addition, the buyer remains at risk of having the government foreclosing on the restaurant and its property if the seller for some reason stops paying. (There is a caveat here: if the loan documents were specific about what property forms the collateral, and you retain that property in the possession of the company that took out the loan, then you might be able to sell the remaining assets. Again, consult an attorney.)

By the way, it could be and may be worse. The loan is not part of the capital gains formula. If you net out at zero on closing day, you may still have a sizeable tax bill.

Bottom line? If you took out one of those loans, now would be a good time to figure out how the loan is going to be paid off. If that won’t be possible, be ready to sell your business for next to nothing.

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