Buying a company's debt can mean two different things depending on what's happening when you use the term. It's possible to acquire a company along with its debts or to just buy individual loans the company has taken out. In both cases, one entity is paying money for money owed by a company in hopes of profiting from the transaction. Beyond that common point, the two practices differ considerably.

Buying Money Owed

If a business owes money on a loan, the lender has the right to sell that debt to a third party. When that happens, the company buying the loan secures the right to collect that money. This secondary owner of the loan would hope to make a profit off the interest, just like the original owner did. Collections agencies make their profit by buying debt this way.

Buying an Indebted Company

At any given time, most businesses have some debt. If an owner sells her business, she has a few ways to handle any debt outstanding on the company's accounts. She can set a higher price for the company and pay the debt with proceeds of the sale, or she can set a lower price and pass to the buyer all responsibility for the unpaid loans. Or she can "split the difference," paying some of the debt and transferring some of it to the new owner.

Pros and Cons of Buying Debt

The plus side of buying debt is that it creates a stream of income for you, the buyer, without any additional work. You're buying a tested profit generator, and the initial issuer of the loan has already done all the sales work. You just have to administer the loan and enforce collection on the payments. The biggest disadvantage is that you're taking on the risk the borrower will default on the loan. If that happens, you've spent money to buy debt that won't generate the profits you imagined -- and might not even return your principal.

Pros and Cons of Buying a Business With Debt

Buying a business with debt gives you a lower upfront purchase price. That makes it easier for you to buy the business and gives you more capital for the early years of operation. This works well as long as you can improve the company's profitability and pay off its debts. Otherwise, the payments associated with the debt you acquired will soak up the cash flow you otherwise could use to grow the business, hamper your ability to obtain additional loans and increase your overall financial risk.

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