What Happens to a Shareholder Loan if the Company Is Sold?
Business endeavors sometimes require more money to stay afloat than was originally planned. While a corporation can take out a loan from a bank or another third-party lender, it can also borrow money from its own shareholders. A shareholder loan is a business debt that must be paid off according to the terms of the transaction, regardless of who owns the corporation.
When you set up your business as a corporation under state law, you create an independent legal entity that exists separately from its owners. A corporation has many of the same rights as a person to conduct business in its own name, including signing contracts to borrow money. Most importantly, a corporation continues to exist as a responsible entity even if one or more of the shareholders change. One of the main benefits of organizing your business as a corporation is that transferring the business from one group of owners to another doesn't necessarily affect the status of assets and liabilities that are in the name of the business.
Owners of small-business corporations sometimes fund operations out of their own pockets. These cash infusions can be classified as equity or debt on the company's books. Equity is a cash infusion into the business in exchange for an ownership percentage in the form of stock. The shareholder only gets all or a portion of this money back when he sells his ownership interest. Debt is a loan of money from the shareholder to the business. Ideally, this transaction should be properly authorized by the board of directors and documented in writing in the same way as a loan from a third party. The corporation must pay the loan back according to the terms agreed upon by the board.
You can sell a corporation by transferring 100 percent of the company's stock to new shareholders. The new owners step into the shoes of the old shareholders, and the corporation continues to operate legally as if nothing has changed. All the debts the corporation owed before the ownership change continue in effect, including any debts owed to prior shareholders. If the corporation defaults on a loan from a prior shareholder, she can sue the company for repayment.
Shareholders of small corporations can be reluctant to walk away from the business while still owed money, as they'll have no control of repayment once the company is taken over by new owners. Typically, the terms of a shareholder loan will require the company to pay back the loan in full prior to sale or out of the proceeds of the sale. Alternatively, repayment of the loan and any other debts that are specifically tied to existing shareholders can be negotiated during the sales process so that the old owners can walk away from the business free and clear.