New business shouldn't inherit partner's old debt
By Elaine Pofeldt | Published: March 23, 2015
Your Business Credit
Dear Your Business Credit,
A guy I'm going in partnership with has an S corporation. I have a business license. We were thinking about forming a limited liability corporation (LLC) together, with a new name. Would I inherit his debts from his S corporation? -- Dwayne
I wish more entrepreneurs would ask questions like yours. The best time to find out the answers is before you're legally joined at the hip.
To answer your question, it looks like you would not inherit those debts. But you should still get advice from a lawyer before signing any paperwork with your partner so you can be certain.
I ran your question past Leslie Tayne, an attorney in Melville, New York, who advises small-business owners on credit-related matters. "No, you would not be responsible for debts from his S corporation, unless you assume those debts when you form the LLC," she said in an email. But she noted that she had limited information on your situation and answered based on what she knew of it.
Inheriting your partner's debt should not be your only concern in this situation. I'm assuming you have already done some due diligence on your potential partner, given that you know about his debts -- or have a candid relationship and he brought them up. Still, even if he is a good friend, I would suggest you hire an attorney to do routine due diligence on him, if you can.
I'd be very curious about what led to the debt at his previous S-corp and what kind of debt it was. Was he investing in growth and borrowing from a bank at a low interest rate -- or turning to hard-money lenders in desperation because he couldn't make payroll? An attorney will ask the probing questions you really need to address, but might feel awkward asking.
I'd also want to find out exactly how your potential partner is handling his debt from the S-corp. Is he paying it back in an honest, upfront way, struggling to make minimum payments or actively dodging it? You need to understand his financial situation and past behavior to judge whether he will be a good partner for you.
If, for instance, he has damaged his credit severely, that will affect your LLC's access to credit. Lenders often look at small-business borrowers' personal credit in a startup or very small firm, because the business won't have much of a credit history. If your partner can't realistically get a bank loan or other credit with you, you will probably need to do the borrowing and put your own credit on the line. If that's the case, you need to figure out if you're ready to play that role.
Partnerships can be a great way to expand your capabilities as a business owner. But it's very important to ask the tough questions early. In the best teams I've seen, the partners are extremely direct with each other and bring difficult issues to the surface early. I think you're on the right track with this, but you need to keep going and dig until you know the full story.
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