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Transferring Ownership of a Business

There are times when a business must be sold for one reason or another.  Many people start a business with dreams of running it forever and passing it to their family down the road only to find they need to sell due to unforeseen circumstances.  Others start a business with hopes of selling it for a profit after they have built the business into a money maker.  And some people sell simply due to retirement, change of heart or an unexpected offer.  Whatever the reason for the sale, there are several ways to transfer ownership of a business depending on which type of business you have.

What Type of Business is it?

How you go about a transfer of ownership will often depend on what type of business it is.  And each type will have different state and federal rules and regulations governing transfer of ownership.

  • Sole Proprietorship – If you are the sole owner and operator of the business and have no partners then your business is a sole proprietorship. A sole proprietorship is the simplest form of company ownership. The company isn’t treated as a separate legal entity such as a corporation, and the profits, as well as the liability fall exclusively on the owner. This type of company exists only if the owner is actively engaged and conducting business. They are not governed by the same rules as a corporation and since the taxation of the business is simply earnings taxation of the owner they can mix business and personal expenses. Sole proprietorships may also be partnerships.
  • LLC – Limited Liability Corporations, or LLCs, are incorporated entities and are treated in terms of legal standing a “person”. As a business grows an owner may want to incorporate to change the level of personal liability they have in the company or to improve their tax status. LLCs have several advantages in terms of taxation, liability and longevity.
    o Most states allow corporations to elect for perpetual duration, meaning the company and its assets will survive the death of those with ownership.
    o Another advantage of filing as a corporation is that it separates the business assets of the company from the personal assets of the owner. This allows an owner’s personal assets to be protected against any liability issues that arise with the company itself. In a sole proprietorship, the owner shoulders the liability burden.
    o Owners can also realize other tax benefits for incorporating that are not available to them as sole proprietors.

LLCs generally fall into two categories:

  • “S” Corporations by law have a limited number of shareholders (100 or less), are restricted to US citizens and allow “Pass-Through” taxation. An “S” Corporation is also not taxed twice on income and dividends. The “S” Corporation designation makes best sense for small businesses moving the level of an actual corporation.
  • “C” Corporations have the same legal status and protections but they allow ownership from abroad and can have more than 100 shareholders. They are taxed on both income and dividends and more commonly are much larger businesses.
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How to Transfer Ownership

When the time arises for an owner to exit the business the sale will be based on the type of ownership discussed above.  Additionally, what type of sale you undertake will depend on your personal goals.

Sale of a Sole Proprietorship:

  • Outright Sale – In an outright sale the owner sells the business and assets to a buyer for an agreed upon sales price.
  • Gradual Sale – In this arrangement an owner sells the business and assets over time per pre-arranged agreement. This is a more flexible type of sale that can benefit a buyer who may not have the funds to purchase a business outright. The former owner continues to receive monthly payments for the business until the sales terms have been met.
  • Lease Agreement – A lease agreement allows an owner to transfer ownership of the business through a lease. The lease terms will dictate the payments to the owner and the terms. It may also allow the owner to reassume control down the road or engage in a different type of sale after the terms of the lease expire.

Sale of a Limited Liability Corporation – The sale of a small business that has status as a corporation has different rules legally governing sale and transfer.

  • LLCs, especially “S” Corporations, need to have a business continuation agreement. As a more closely held type of business ownership, this agreement governs how ownership of a partner’s shares will be transferred and who will assume that ownership. In the absence of a business continuation agreement the LLC would need to be dissolved in the event of a bankruptcy or death of a partner.
  • An LLC may also have adopted agreements governing how the transfer may take place. Generally, these agreements can require the consent or vote of the other partners and involvement by shareholders as to how and who the ownership may transferred to.

Additional Things to Consider

One of the biggest considerations for transfer of ownership concerns are those operated as family businesses.  Transfer of ownership in these cases is not necessarily based on sale to an interested party, but in a transfer as an older owner exits the business through retirement and a younger family member assumes control.  This could also happen in the event of the death of the owner and the family desiring to continue the operation of the business.

In these cases, the transfer could be complicated by additional levels of regulation and legal responsibility based on estate taxation if the owner has died and through gift tax liability if the owner has begun to transfer ownership to family as the current owner approaches retirement.  The best hedge against these possibilities is strong proactive action over time by current ownership with their accountants and legal representation to reduce or mitigate the effects of this type of transfer.

Planning, Planning, Planning

Regardless of the type of business you own there is no substitute for a plan of sale or a succession plan to protect your ownership and your family in the event of death or tragedy, or if you simply want to retire and watch your family grow and increase your legacy.  While ownership transfers do not have to be painful, planning through retention of accountant and a legal firm specializing in business sales and transfer agreements will help reduce the burdens on both you and your family when the time comes.