When an investor buys a business, the investor gains the right to collect some obligations that are due to the business, and may take on some of the debts of the business. The exact arrangement depends on the purchase contract, so the investor may assume all of the liabilities of the business, some of the liabilities, or none of the liabilities.
Assuming the debts of a business can allow an investor to purchase a business for a very low cash payment. The current owner may sell the business for much less than the value of its equipment and buildings because the investor is taking on debt repayment obligations. The arrangement allows an investor who does not have much cash available to purchase a valuable business.
When an investor agrees to assume the existing debt of a business, the contract may include language that establishes that the investor is only liable for debt that the business incurs before a certain date. This clause is important, because the business may be able to take out additional loans before the sale is complete, creating additional liabilities for the buyer.
If the business owes money to the buyer, the sale of the business cancels all of the business' debt to the buyer. According to the Gonzaga Law Review, this debt cancellation is considered a cash payment, which is important because some state business sale regulations require the buyer of a business that holds a certain license, such as a state liquor license, to provide a certain percentage of the value of the business as a cash down payment.
Assuming the debts of a business can be beneficial to the buyer, because a business can deduct its interest expenses on its federal income tax return. If the buyer does not assume the debts of the seller, and pays a higher cash price to buy the business, the buyer will not gain this tax deduction. Businesses prefer to have some debt at all times because of this tax shield effect. The business may want to assume debt, instead of taking out a loan itself, if the existing loan has favorable terms.
When the buyer assumes the debt of the business, the buyer is agreeing to the terms of the original loan. This is important if the debt is secured debt, because the lender has the right to repossess assets that the business owns. The buyer may decide to take out an unsecured loan to pay off any secured loans so creditors can't repossess production equipment, although the buyer will have to pay a higher interest rate because the loan is unsecured.