You may be responsible for the debts of a business you buy, depending on the legal structure of the business, how the purchase is structured, and the type of debts involved. Generally, if you buy only the assets of a business, you may not be liable for the debts of the business. But if you buy an entire business, such as all the stock of a corporation, you would generally be buying all assets and liabilities of the corporation.
As pointed out on The Entrepreneurs’ Help Page, if you are buying the assets of an existing business, there may be tax or other liens on those assets. Before purchasing the assets, you should do a due diligence and review the public records regarding liens. If there are liens, you should request the seller to pay the liabilities and obtain a release of all the liens.
When you buy the stock of a corporation or the membership interests in a limited liability company, you would generally assume all existing liabilities. And you may also assume future obligations that are not known at the time of the purchase. For example, an IRS audit could reveal tax obligations that apply to periods before you purchased the business. But as the new owner, you could be held liable for payment of those obligations.
Because of the unpredictability of potential tax obligations, The Entrepreneurs’ Help Page points out that the buyers in stock purchase transactions generally require the seller to indemnify them against any obligations that apply to the period prior to the sale. Or a clause can be included in the purchase and sale contract to set up a special escrow account with a portion of the purchase price to pay any tax liabilities that arise after the sale.
When you buy a business, you may have to request a certificate of tax clearance from the state tax or revenue department. As indicated by the California State Board of Equalization, in order to protect yourself from liability for sales and use taxes owed by the business you are buying, you must contact the Board and request a certificate of tax clearance. If you do not obtain that certificate, you are required to withhold enough of the purchase price to cover any taxes owed until the seller produces a receipt showing that the taxes have been paid, or a certificate is received from the Board stating that no tax is owed.
As Joe Sandbank points out on the BizBen blog, as the buyer, you may also be required to withhold an amount to cover the seller’s unpaid contributions to the California unemployment fund, employment training fund, and unemployment compensation disability fund. You should check with your state tax or revenue department to see if there are similar requirements in your state.
As indicated by Brian Rogers on the iVLG blog, when you purchase the assets of a business, the agreement would generally be that the assets are sold free of all liens and encumbrances. But if there are liens on the assets, those liens remain in place after the assets are purchased, unless the creditor releases the lien. It is therefore important to search the public records to identify any liens on the assets, and then ensure that the seller pays off the debt and that the liens are released before the purchase.
If the seller needs the proceeds from the sale in order to pay off the debts, you can obtain a document stating the amount of the debt, with a commitment from the bank or other creditor to release the lien once the debt is paid. In this case, you as the purchaser would generally pay that amount directly to the bank or creditor, rather than to the seller.
Buying Business, The Entrepreneurs’ Help Page
Buying, Selling, or Discontinuing a Business, California State Board of Equalization
Brian Rogers, Avoid Unwanted Liabilities When You Buy a Business, iVLG
Joe Sandbank, Successor Liability When Buying A Business, BizBen