When a business is owned by more than one person, there can come a time when someone wants to leave. Even in the most amicable circumstances, this is a new deal with each owner on a side. A while ago, a client of mine bought his partner out of the business. Because neither side thought through the tax implications, the selling partner got hit with nearly half a million in income tax after the sale. When time comes for one or more business partners to move on, there is more than following the formalities. There are hidden issues that both sides should consider. Depending on the structure of the deal, taxes, liability assumption, regulatory compliance, and other matters can end up hurting one or both of the parties. Here are some issues to consider when the sale of a business is being contemplated:

  1. Is there an existing contract setting the rules?

Where more than one person owns the business, the formation documents are likely to hold some restrictions and rules. Examples include bylaws for corporations, operating agreements for limited liability companies or partnerships, or buy-sell agreements. These documents dictate issues of valuation, right of first refusal, tax allocation and whether the purchase needs to be paid in a lump sum or over time. Of course the parties can agree to use different terms, but when there is tension in the sale or a focus on moving on, these are useful guidelines to rely on. Often in legalese – and sometimes simply the default standards set by state law – it’s a good idea to confer with counsel on the meaning of the terms to understand what to do and decide whether to use them or agree to an alternative.

  1. What is the Valuation?

Putting a price tag on a company can be one of the most controversial and expensive parts of a sale. Brand name, customer lists, credit facilities, and real estate leases are only some of the items that can add value to a company. In this day and age, social media, website presence and other marketing strategies have a value as well. Also, the existing liabilities like loans and credit facilities as well as potential liabilities from third party claims can take away from the value of a company. In addition, both buyer and seller will pay attention to the business’ potential to earn income and the potential liabilities. There are a number of ways to project income and assign the value of this potential as part of the sale. There are valuation experts called appraisers who will review the company as a whole and come up with a price. Appraisers don’t work for free, so their services eat into the add to the cost and profits of the sale. Another resource is the company accountant. A review of the company profits and losses over a several year period and the balance sheet can help identify company assets, income stream and owner capital – all important factors to consider in the value of the company.

  1. Are there Tax Issues?

Capital gains and income are taxed at different rates. Installment sales and lump sum sales implicate the applicable tax year. Sales tax, asset depreciation and many other factors play into the tax consequences of a sale. Asset purchases are treated differently from sale of stock, membership or partnership interests. Many attorneys who are familiar with basic corporate law may not have the expertise to identify these issues. Working with an accountant or a tax attorney can save huge amounts in taxes. The tax burden will be different for the buyer and the seller, and the implications of the structure of the sale is an important consideration when arriving at the sale price.

  1. Can the Small Business Prevent Competition?

What happens when a partner leaves and wants to set up a competing business. Most business sales include some form of non-competition provision. The terms usually cover issues like recruiting employees, using customer lists, geographical business location and time limits. In order to be enforceable, a non-compete needs to comply with legal limits that vary from state to state. Understanding the limits to non-compete agreements in your jurisdiction is the difference between an enforceable term and a potentially useless provision.

  1. What About Liability?

Business entities are formed to shield the individual owners from personal liability. That shield is something the departing partner will be interested in extending past the transfer. But there are times when an owner has done something so wrong that a suing party can “pierce the corporate veil.” The transfer should address both the basic shields owners expect as well as what happens if one or more of the partners has acted in a way that exposes all the partners to personal liability. The transfer agreement should have indemnity provisions, which both parties should look at carefully.

Each time a small business changes hands, there are going to be unique issues that come up. The topics discussed in this article are focused on the breakup of a business partnership. There are many more considerations that depend on the type of business, and a whole range of different issues in a third-party sale. Due diligence, a good attorney and careful review of the terms are critical to obtaining the outcome you want and avoiding unintended consequences.

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