There are times when a business owner wants to get out of business. With the recent down economy many people have either left, or want to leave, their current businesses. But getting out is not so easy, especially when there is a mountain of debt the business has accumulated over time.
A more positive aspect of business succession is when an owner simply wants to pass on the business to her children and grandchildren. Deciding on the best way to exit a business can have important and long-lasting ramifications for the soon-to-be ex-business owner.
Here are a few options to consider when you reach quitting time:
Scenario Number 1: Business owner has too much debt and wants to dissolve his business (and his debt).
Dissolving a business in California is relatively easy, but dissolving debt is not. For example, if your business is formed as a corporation, limited liability company, limited partnership, or any other type of entity, you can dissolve that entity with the Secretary of State’s office with a few simple forms. But there’s a catch, and it’s a BIG catch: once a corporation is dissolved the debts and liabilities of the corporation must pass to someone else. The dissolution forms require you to name a person who will personally take on the debt and liabilities of the corporation after it is dissolved. This is a huge problem because you likely formed the corporation in the first place to limited yourself from the debts and liabilities of the corporation. So why take those debts and liabilities on personally now?
All too often I have clients come into my office and tell me that they dissolved their business and so the debt is no longer a concern. Not so. In fact, if a business is dissolved without resolving the debt issues, then you just made matters worse because debts that may have been limited just to the entity before are now on your own personal balance sheet after dissolution.
The correct approach is to resolve debt issues before dissolving the business entity. Resolution could take many forms from negotiating the debt to a smaller amount so it can be paid, to filing for bankruptcy protection for the entity so the debt is discharged either in whole or in part prior to dissolution. Either way, the debt must be dealt with first. Never dissolve a business entity that has debts and liabilities.
What about debts that the business owner guaranteed personally? That may require a personal bankruptcy to resolve. The point is to look at your options before dissolving anything.
Scenario Number 2: Business owner wants to transfer business to family member to avoid creditors.
Let’s be clear right up front, this never works. Transferring the ownership and management of a business entity to a family member in order to avoid a creditor is fraud, plain and simple (called Fraudulent Transfers under the law). And courts generally disfavor this type of tactic because it just causes a huge mess.
Plus, transferring a business means giving up control, so the business owner is no longer calling the shots from a legal view. This means that once the business ownership and management is transferred to someone else, you are powerless from stopping them from taking actions you may not like.
It is far better to simply deal with creditors head on. It may seem painful, but it’s the only way to resolve the problem. And the worst that can happen is a bankruptcy filing. Bankruptcy is there for a reason, to help people who need help with creditors.
Scenario Number 3: Business owner wants to sell a business.
There are many ways in which to sell a business to a new owner. A sale is a great way to pass a business on to the next generation without having to worry about gift tax implications (because it’s not a gift, it’s a sale). My advice to every business buyer: pay as little up front and push as much of the purchase price into monthly payments as possible. My advice to every business seller: receive as much of the purchase price as possible up front and don’t allow any payments on the purchase price, if possible (unless you want to spread payments over time for tax purposes).
Simply put, sellers want their money (all their money) up front when selling, and buyers want to pay as little as possible up front. And there are safeguards that can be built into sales contracts to ensure the business either continues as it has in the past or the purchase price must be adjusted to account for the change.
The one thing to remember in selling a business is to have all the terms agreed to clearly articulated in a written sales contract. If there is a down payment with the remaining purchase price being paid over time, then determine how those payments will be made, when they will be made, and what will happen if they are not made. You will want to have some mechanism built in so that if payments are not made, the business can be re-possessed without going to Court. The best way to secure payment is with “security”. Security is a legal term that generally refers to being able to take something of value from the buyer without having to go to court first.
Scenario Number 4: Business owner wants to gift business to a family member.
Gifting a business to a child or grandchild can be a bit tricky, but not impossible. Many people gift an interest in their business to children when they add them to the ownership percentage. If I add my son to my corporation as a 10% shareholder, I have just made a gift to him of 10% of my company value. Unless my son actually pays me for that interest, the transfer of 10% to him is a gift.
When making a gift of a business interest, you are required to have that interest appraised for gift tax purposes. Also, if the interest gifted is greater than $13,000, then you also have an obligation to report that gift to the IRS (using Form 709). Fortunately, for 2011 and 2012, each person is allowed to gift up to $5,000,000 during their lifetime without having to pay gift tax. So unless your business is highly valued, a gift of a business interest comes with a reporting requirement, but no real gift tax consequences. For that reason, now is good time to consider making a gift of part or all of your business to the next generation.
Of course, when you make a gift, you must give up control of whatever is gifted. That means you will give up control of the entire business if you choose to gift it to a child or grandchild. But you can still be involved in the business, and even be an employee of the business. You just won’t be an owner and you won’t call the shots any more.
Adding a child or grandchild could also change the income tax consequences of your business, depending on the type of entity you have. Be sure to check with a tax professional before making any gift of a business interest. And remember that the addition of anyone as a shareholder, member, partner, or owner of any type is a gift unless that person pays you full value for the interest.
These are just a few examples of the way in which you can exit your business when quitting time arrives. Make sure you know your available options and never obligate yourself for your business’ debts and liabilities if you can avoid doing so. If done correctly, exiting a business can be a pleasant experience.