Finance due diligence when buying a business: loan agreements, overdrafts and charges

If you are buying a business, you need to understand what the company owes and to whom. Loan agreements, overdrafts and charges all stay with the company after the deal completes, and they can jeopardise your long-term plans. This guide covers what loan agreements and charges actually are, the six things to check before you buy, and which documents to request from the seller, so that you can assess a company's borrowing and avoid inheriting liabilities that catch you off guard.

Here is the thing most buyers overlook. The company's existing lender may have a say in whether your deal goes ahead at all. If you are borrowing money to fund the completion payment, the charges the seller's lenders already hold could conflict with your own lender's security requirements. Finance due diligence is how you find that out before it derails the deal, and it is a separate exercise from checking whether the business makes money.

Finance vs financial due diligence

Finance due diligence focuses on the company's borrowing arrangements. That includes any loans the company has taken out, any overdraft facilities it has with its bank, and any charges registered at Companies House in favour of its lenders.

It is not to be confused with financial due diligence, which looks at the financial performance of the company, for example whether it is profitable or not. Both matter, and they are usually done by different people. Financial due diligence is typically accountants' work. Finance due diligence, reading the loan documents and the security, is what this guide is about.

Do you inherit company debts in a share purchase?

Yes. When you buy a company through a share purchase, you inherit everything related to that company. That includes its debts and its obligations to lenders. The lender's position does not change because the shares have changed hands, and the lender does not need your agreement to keep enforcing the terms it already has. So you need to know exactly what commitments are in place before you become the owner of them, and you need to decide, with the seller, which of them will be cleared at completion and which will stay.

What is a charge over company assets?

A charge is a form of security that a lender takes over the company's assets. If the company defaults on the loan, the lender can enforce that security and sell the asset to recoup what it is owed. So you need to understand what charges exist and which assets are covered by each of them.

This matters even more if you are using finance to fund the acquisition. Your lender is very likely to want some kind of security over the assets of the company, and if there are already charges in place there could be a conflict between the two. Getting this wrong can delay the deal or derail it completely.

The six things to investigate

• Check every loan agreement. Start by asking the sellers and the directors what loan agreements the company is a party to. A loan agreement does not need to be in writing. It can be verbal, especially where it is between the company and a director or shareholder connected to it. So the question covers bank loans, shareholder loans and any informal lending arrangements. For each loan you want to know the principal amount owed, the interest rate and the repayment terms. Do not overlook loans from people connected to the sellers. They are common in smaller companies and often have unusual terms, precisely because nobody negotiated them at arm's length.
• Who is the lender? It matters whether the lender is a bank, an institutional lender, or someone connected to the sellers. If the loan is from the sellers or their associates, you need to understand what happens to it on completion. Will it be repaid out of the purchase price? Will it be left in place? And if it is left in place, what are the repayment terms, what is the interest rate, and what other terms and conditions are attached to it? Whatever is agreed needs to be written into the deal documents, because once the sellers have gone you will be dealing with that loan on whatever terms were left behind.
• What are the repayment terms? For each loan, is there a fixed repayment date, is it repaid in instalments, or can the lender demand repayment at any time? Loans repayable on demand are a huge risk, because the lender could call in the debt after the deal completes. If you, or the company, do not have enough money to repay the whole amount, that could put the company into insolvency.
• Review all charges and security. Loans are only half the picture, because the security attached to them is what gives a lender real power over the company's assets. Search the Companies House register for any charges registered against the company. A charge gives the lender rights over specific assets if the company defaults, so check what assets are covered by each one. A common example is a floating charge over all the assets of the company, or a fixed charge over specific property or equipment. You also need to understand the priority of each charge, meaning which lender gets paid first if the security is enforced.
• Check for conflicts with your own lender. If you are borrowing to fund the purchase, your lender will usually want to be first in priority, and existing charges could block that. You need to establish whether the existing charges will be released on completion, or whether your lender is willing to take a lower priority position behind them. This is a conversation to have early, because it involves the seller's lender as well as yours.
• Is the company a guarantor? A limited company can act as guarantor for another borrower, even in a transaction that has nothing to do with what the company actually does. Find out whether the company has guaranteed the debts of any other person or business. A guarantee is a contingent liability: if the original borrower defaults or cannot repay, the guarantor, meaning the company, has to step in and pay instead. That could have serious consequences after you take ownership, because the liability does not show up as a loan the company itself has taken out. You only find it by asking the question and reading the guarantee.

Due diligence documents to request

• Loan agreements. Ask for copies of every loan agreement the company is a party to. Where there is a director's loan with nothing in writing, ask the sellers to put a document in place before completion so that you can review it. For each document, read the terms carefully, paying attention to the repayment date, any change of control provisions that might be triggered by your purchase, and any active obligations on the company, for example a requirement to keep specific insurance cover in place.
• Charge documents and debentures. A debenture is a document that creates a charge over the company's assets. Review each one to understand what security is in place and which assets are already taken by existing lenders. Compare what you find against the Companies House charges register.
• The company's books and accounts. The financial accounts and the books of the company should detail every liability the company has, who it is owed to, and what payments have been made. Loans between the directors and the company are usually recorded here too, which makes the books a useful cross-check against what the sellers have told you.

Next steps

Build these questions into your due diligence questionnaire at the start, and get the Companies House charges search done early so that any conflict with your acquisition lender surfaces before the timetable is fixed. If you are using finance, speak to a corporate solicitor about how existing charges will be released or subordinated at completion, and make sure the SPA deals with any seller loans that are staying in place. The next area to cover is commercial due diligence, which I explain in commercial contracts due diligence.