While small business owners are great at running and operating a business, most know very little about selling their assets or transferring ownership. In-fact, many owners believe that passing their business onto their children will be a simple transaction. While it may seem like a straight-forward private matter, transferring ownership—regardless if it’s to a child or to an external buyer—can be a lengthy and complicated process.
Perhaps the first thing to consider is your current business structure. A business structure is the legal entity through which an owner chooses to conduct their business. Properly-formed incorporated businesses like LLCs and Corporations are treated as their own separate legal body. On the other hand, nonincorporated structures (such as General Partnerships and Sole Proprietorships) aren’t considered a separate legal entity.
This is an important distinction to understand when trying to sell your business to a family member. Since a Sole Proprietorship isn’t incorporated, it’s simply treated as an extension of the owner. In other words, all of the assets of the business are in-fact just personal assets of the owner. There really isn’t a “business” to sell, only a collection of the owner’s tangible and intangible assets.
So can you sell your Sole Proprietorship to your children? Not really, as there’s no distinction between business and personal assets, thus no “business” to sell. Instead, all of the business assets (again, which are technically the owner’s personal assets) can be valued and sold to an incoming owner, who can then use them to form a new business.
The Process of “Selling” your Sole Proprietorship
For owners of Sole Proprietorships, the business assets are the personal assets. However, this doesn’t mean that they can’t be valued, traded, and retailed to potential buyers. Tangible assets like equipment or work vehicles can certainly be sold or gifted. The difference, however, is that the buyer or recipient isn’t legally assuming ownership of the “business”. Instead, they are only purchasing personal assets, which they can then use to form their own business. Many legal professionals would then suggest that this “new” business gets properly incorporated.
In-fact when an owner steps-away from their Sole Proprietorship, their business (namely their employer identification number and their DBA name) automatically gets dissolved. Once the business is dissolved, a new business can be created in its place. This is perhaps the closest thing to “selling” a Sole Proprietorship. The owner would sell their assets to a buyer and the business is dissolved. The buyer then uses those assets to form a new business in its place, which doesn’t necessarily have to be a Sole Proprietorship. The new business isn’t legally affiliated with the previous business, although it can usually operate under the same brand or name. However, the new business must apply for its own employer identification number.
A major challenge with selling a Sole Proprietor’s assets is the issue of valuation. Like valuating a business, valuating individual assets is a nontrivial task. The issue is arguably more cumbersome for owners of Sole Proprietorships, as their businesses assets are personal assets.
Another issue with valuation arises when trying to place a price on an intangible asset. In many Sole Proprietorships, it’s the skills and expertise of the owner that gives the business its true worth. However, it’s difficult—perhaps impossible—to value an individual’s technical skill or social capital. Examples might include business contracts or client lists; these are indeed assets, but intangible ones. Most owners will gladly gift these assets to their children, but if you wanted to sell instead of gift, they aren’t easily valued.
Should I Incorporate my Business?
Once a business is incorporated—in other words, is registered with the state as an LLC or Corporation—it can then be sold or transferred to a family member through the transfer of business shares, business assets, and a well-executed buy-sell agreement. Importantly in these situations, the assets being transferred are indeed the assets of the business, not the personal assets of the owner. These often come in the form of tangible assets or share certificates of ownership.
There are a number of advantages to incorporating a business. Perhaps most importantly is the legal distinction created between the owner and the company. Once a business is incorporated, it is treated as a separate legal entity with its own liabilities, financial accounts, assets, and tax responsibilities. It’s this distinction that disallows owners of Sole Proprietorships to sell “business” assets. Remember, when a business isn’t incorporated, it’s liabilities and assets are in-fact the personal responsibilities of the owner.
Does this mean that owners should hastily restructure to incorporate their business before selling? Likely not; incorporation is a big decision, and largely depends on the type of business, its risk-level, it’s yearly revenue, and its ownership structure. In any case, a legal professional should be consulted. Incorporation isn’t appropriate for all business models, and the decision to incorporate shouldn’t be contingent solely on selling a business.
It's important to remember that almost all types of business sales will be accompanied by taxes. In the case of formally incorporated entities, selling shares or other tangible business assets will be levied a tax. Conversely for Sole Proprietorships, the sale of personal assets is taxed by state- and federal-agencies (as are gifts, albeit to a lesser extent). For owners looking to sell their Sole Proprietorship to their children, taxes and liability must be minimized. Again, expert advice should be obtained in these situations.