Drowning in business debt!?! Even when a company's sales start increasing, debt can eat away at the profits...
More and more small business owners are finding that profits are going to servicing their debt and keeping their business operational. In such cases, an option is to sell the business through a short sale. Especially if a business owner is burnt-out, looking at shuttering the business and declaring bankruptcy.
Declaring bankruptcy is different as a small business owner. It's not just an anonymous bank or bureaucratic phone company that is owed money; it's often suppliers and vendors with whom there are long-term personal relationships. And often, friends and family have invested in the business or lent large sums of money to help keep the business afloat.
A short sale can provide creditors at least a portion of the funds owed to them, while alleviating the small business owner of having a bankruptcy tied to their name and credit. It can also save the jobs of the employees.
Special note for franchise owners - If the business is under a franchise agreement and the franchise payments are grossly in arrears, there is a chance the franchisor can take back the business, leaving the owner without a business and still holding all the debt. It is in the interest of the franchisor for the business to sell and bring in a new owner who will start paying royalties.
How it works -
An experienced and competent business broker will package the business based upon its net profit and assets. The debt and other non-operational expenses will be added back to the net profit and an industry appropriate multiple will be determined. If the business sells for less than what is owed, it is a Short Sale. If it sells for more than what is owed, the owner will receive whatever is left over after all the debt is paid.
In a normal sale, an escrow is used primarily to protect the buyer from successor liability - any debt attached to the business. In a short sale, the escrow process also aids the seller in settling the business's debt.
Once all the debt is established, the escrow officer will prepare a seller's estimated statement reflecting all secured and unsecured debt. Secured debt includes tax liabilities, private liens, judgments, etc. Unsecured debt includes private loans. If the sale price covers all the secured debt, the remaining funds are distributed pro rata to the unsecured creditors. If the sale price doesn't cover all the secured debt, remaining funds are distributed pro rata to the secured creditors.
All creditors will need to agree on the payout in order to close the deal. Since the alternative is usually bankruptcy for a small business owner, creditors would prefer to receive something rather than nothing. Thus, they generally will agree to the pro rata payout.
Although short sales are messier than regular business transfers, they are a win-win for the buyer, the seller and the creditors. The buyer gets a good deal on the business; the seller avoids bankruptcy and is alleviated of their debt while their creditors get something rather than nothing.