In most acquisitions the target's debt is paid off at closing out of the purchase price. Each existing lender issues a payoff letter stating the exact amount due and agreeing to release its liens once paid, and the closing funds flow wires it directly. The new lenders will not fund until every lien on the collateral is cleared or, less often, subordinated to them. The existing revolver, term loans, equipment financing, tax liens and old UCC filings all need the same treatment. A few debts can be kept with the creditor's consent, but most change-of-control clauses make that the exception.
- Usual treatment
- Paid off at closing from the purchase price, directly to each creditor
- Document the payoff rests on
- A payoff letter with a good-through date, daily interest and a lien release undertaking
- What the new lenders check
- UCC, tax lien and judgment searches against the target and related entities, repeated just before closing
- What must be clear at closing
- Every lien on the collateral: paid and released, or formally subordinated
- Common cause of a slipped closing
- A late-found filing or a creditor slow to issue a payoff letter
Why the new lenders need a clean slate
An acquisition lender underwrites its loan on the basis that it will hold a first lien on the company's assets, and in most deals a pledge of the target's shares or membership interests as well. It cannot hold a first lien if someone else already has one. A lien follows the collateral, not only the debtor, so even in an asset purchase, where the seller's entity keeps its debts, a creditor with a filing against the receivables, inventory or equipment being sold keeps its claim on them after the sale unless it is paid and releases them.
That is why every acquisition commitment carries a closing condition along the lines of: evidence that all existing indebtedness has been repaid and all liens released, other than permitted liens. The UCC-1 financing statement is how most business lenders record their lien; a blanket lien covers everything the company owns. Clearing them is a mechanical task, but it depends on third parties who have no stake in the buyer's timetable.
In a cash-free, debt-free deal, the usual basis at this size, the headline price assumes the business is handed over with no funded debt. Paying off the target's borrowings is therefore not an extra cost to the buyer. It is part of the price, routed to the creditors instead of the seller.
The sequence, from lien search to release
| When | What happens | Who drives it |
|---|---|---|
| Before the letter of intent | The seller provides a debt schedule; the buyer asks for copies of the credit agreement, notes and leases | Seller, buyer |
| At the lender package | The target's debt schedule goes into the financing model and the sources and uses | Buyer and its advisor |
| During diligence | Lien, tax lien and judgment searches against the target, the seller's entities and often the owners, in each state where they are organized or operate | New lenders' counsel |
| Once liens are known | Payoff letters requested from each creditor, with a good-through date near closing | Seller, with buyer's counsel chasing |
| Days before closing | Bring-down search to catch anything filed since the first search; payoff figures updated for the actual date | Lenders' counsel |
| At closing | The funds flow wires each payoff directly to the creditor from the purchase price; the seller receives the balance | Closing agent or escrow |
| After closing | Creditors file UCC-3 terminations, release titles and close control agreements; the lenders confirm | Paid-off creditors, then lenders' counsel |
The payoff letter is the document the whole process rests on. It states the principal, accrued interest, any prepayment premium, breakage and fees as of a date, the daily amount that accrues after it, wiring instructions, and the creditor's agreement that on receipt of the stated sum it will release its liens and file a UCC-3 termination, or authorize the buyer's side to file one. Lenders will not accept a phone call or an online balance in place of it. What a good payoff letter contains is covered in the business loan payoff letter.
How the payoff shows up in sources and uses
The sources and uses can show the payoffs as separate uses or net them inside the price, as long as the funds flow matches. Showing them separately is clearer for the lenders, because it shows exactly how much of the price reaches the seller.
| Sources | Amount | Uses | Amount |
|---|---|---|---|
| Senior term loan | 5,000 | Payoff of target's bank term loan | 1,400 |
| Revolver drawn at close | 500 | Payoff of target's revolver | 450 |
| Seller note | 1,000 | Payoff of target's equipment loans | 150 |
| Seller rollover | 500 | Balance of the price to the seller (cash, note and rollover) | 8,000 |
| Buyer's equity | 3,400 | Transaction costs and fees | 400 |
| Total | 10,400 | Total | 10,400 |
Two points matter to the lenders here. First, the payoffs must be accurate: a payoff that turns out larger at closing, because of a prepayment premium, swap breakage or a late draw on the revolver, comes out of the seller's proceeds only if the purchase agreement says so. Second, if the seller's net cash proceeds are small relative to the payoffs, the seller has little incentive to cooperate on late surprises. Lenders will look at that ratio.
Debt by debt: what each needs
| Type of debt | Usual treatment | What to watch |
|---|---|---|
| Bank term loan | Paid off; UCC-3 filed; any guarantees from the owners released | Prepayment premiums, and swap or hedge breakage costs |
| Revolver or ABL | Paid off and terminated; deposit account control agreements and lockbox arrangements ended | Letters of credit issued under the line, which must be replaced or cash-collateralized; cash sweeps that continue until the payoff lands |
| Equipment loans | Paid off, with lien or title released; sometimes kept with the lender's consent | Titled vehicles and equipment need title releases, not just a UCC-3 |
| Equipment leases | Bought out, kept with the lessor's consent, or left in and counted as debt | Whether the lease is really a financing |
| Federal or state tax liens | Paid, with a certificate of release, before or at closing | Tax liens can take priority over the new lenders |
| Shareholder loans to the company | Repaid from the price, forgiven, or converted into a seller note or rollover | If kept, they must be subordinated to the new lenders; see shareholder loans and lenders |
| Judgment liens | Satisfied and released of record | Often unknown to the seller until the search finds them |
The late-found filing
A frequent closing surprise is a creditor nobody listed. A regional equipment lender with an old all-assets filing that was never terminated, a vendor that filed against inventory on consignment, a short-term working capital advance a subsidiary took, or a filing against the owner personally that reaches business assets. A seller who thinks of an arrangement as a supply contract rather than debt may simply not list it.
Each is handled the same way: a written payoff or release from the creditor, a wire from the funds flow if money is owed, and a UCC-3. The complications are practical. A creditor that is owed nothing still has to file the termination, and has no reason to hurry. A creditor collecting by automatic debit has to fix its payoff figure for the closing date and stop the debits. And a lien discovered at the bring-down search, days before closing, moves the closing if no one has a payoff letter ready.
Run the lien search early, against every name the target, its subsidiaries and its owners have used. Anything it finds can be planned; anything found at the bring-down search moves the closing.
Keeping debt instead of paying it off
Some buyers hope to keep the target's cheap debt, typically an equipment facility, a vehicle fleet loan or a real estate mortgage. It can be done, but it is the exception. Most business loans contain a change of control clause that makes a sale of the company an event of default, and most asset-secured loans prohibit transfer of the collateral without consent. Keeping the debt therefore needs the existing lender's written consent, a credit review of the new owner, and often new guarantees in place of the seller's.
The new acquisition lenders also have to agree. A retained loan keeps its lien, so the new lenders either carve the financed asset out of their collateral or sign an intercreditor agreement. They count the retained payments in debt service and the balance in leverage, exactly as if the buyer had borrowed it new, and in a cash-free, debt-free deal the balance reduces what the seller is paid. Keeping debt changes who the lender is, not how much debt the business carries. More on how a retained loan is treated after a change of owner is on change of control as a loan default.
Keeping the closing on schedule
- Get a complete debt schedule from the seller with the letter of intent, including the revolver, letters of credit, leases, shareholder loans and anything the owners have personally guaranteed.
- Order the lien, tax lien and judgment searches as soon as the lenders are engaged, not in the closing week, and search every legal and trade name used.
- Request payoff letters as soon as the searches are back, then refresh them for the actual closing date.
- Plan the letters of credit early: the new revolver may need to issue replacements on the closing date.
- Confirm who files each UCC-3 and title release, and whether the payoff letter authorizes the buyer's side to file if the creditor does not.
- Put a clause in the purchase agreement that any debt found after signing is paid from the seller's proceeds.
Midas Partners's package starts from the target's debt schedule and the documents behind it, so every payoff is in the financing model and the sources and uses before a lender sees the deal. A senior banker checks that schedule against the balance sheet before the client approves the package. That does not replace the lenders' own searches, but it means the searches confirm the schedule rather than rewrite it. See the package.
Common questions
- Does the buyer pay off the target's loans?
- The loans are paid from the purchase price at closing, so economically the seller pays them. The funds flow wires each payoff directly to the creditor and the seller receives the balance.
- What if the target owes more than the purchase price?
- Then the creditors will not all be paid in full from the proceeds and will not release their liens without a negotiated settlement. The deal cannot close on a clean lien position until the shortfall is resolved.
- Do I need a UCC-3 termination for every lien?
- The new lenders need evidence that each lien on the collateral is released. For most business debt that is a UCC-3 termination; titled vehicles and equipment also need title releases, and tax liens need a certificate of release.
- What happens to letters of credit under the target's revolver?
- They must be replaced by letters of credit under the new facility or cash-collateralized before the old lender will release its lien. Plan this early, because the beneficiaries have to accept the replacements.
- Can I keep the target's equipment financing?
- Sometimes, with the equipment lender's written consent and the new acquisition lenders' agreement. The retained loan still counts in debt service and leverage, and in a cash-free, debt-free deal it reduces the price paid to the seller.
- In an asset purchase, do the seller's debts matter?
- Yes. The debts stay with the seller's entity, but any lien on the assets being sold must be released at closing, or it follows the assets to the buyer.