Cash Flow Solutions

Transfer of Ownership in an Existing Business: A How To

Two men shake hands over a meal, closing a transfer of ownership deal

Change happens, and your business will face change(s) in the future. So how you as a business owner manage change will impact your company’s success. And it is important that you are prepared because it all comes down to planning. Every business owner should have a contingency plan that outlines the steps that are required to be taken when there is a transfer of business ownership.

For example, you may have made the decision to retire and sell your business. Or you need to bring a new partner aboard because your business is really successful and is experiencing growing pains. Your steps to transfer business ownership depend upon not only your business’ corporate structure but also the nature of the change of ownership. Let’s take a look at two scenarios involving a change in ownership with one for a Limited Liability Company and the other for a corporation.

Scenario 1
You own a small consulting business that is an LLC. You’ve decided to bring on a new business partner, so you can expand your business. The partner is a former colleague who will own a 45 percent stake in the company for a $20,000 investment.

  • Step 1:
    You must first determine if there are any state regulations that require you to document a change in ownership or management. In most cases, if the state did not record any name(s) as the member(s) or manager(s) in the Certificate of Formation, you can report these changes in your annual report. If any names were recorded, you will have to file a Certificate of Amendment with the state to amend the names of the member(s) or manager(s).
  • Step 2:
    It will be important to update the operating agreement as well as any internal documents that refer to ownership and/or management such as an internal partnership agreement. The operating agreement should be revised to include all of the details of your partner’s investment amount and the percentage of ownership the partner receives in consideration of the investment. As an added measure, it may be a sound idea to have the updated operating agreement notarized.
  • Step 3:
    You must issue a membership certificate to your new partner(s), which includes the number of units of ownership. In this example, it is 45 percent.

Scenario 2
You have owned a senior care company for over 30 years and now plan on retiring. The business was formed as a corporation, and you are selling the company to a new owner. This sale will include 100 percent ownership to the new owner.

  • Step 1:
    As with an LLC, you must first determine if there are any state regulations that require you to document this change.  Similar to the LLC scenario, if the state did not record any name(s) as the director(s) in the Articles of Incorporation, you can report these changes in your annual report. If, however, there were name(s) recorded, you will have to file a Certificate of Amendment with the state to amend the names of the directors.
  • Step 2:
    You should put a new shareholder agreement into place that specifies that there is a transfer of the shares of stock to the new owner. In addition to the shareholder agreement, you must issue the new shares of stock to the new owner.
  • Step 3:
    All of the documented changes should be kept organized in the corporate kit.

Common Transfer of Business Ownership Questions

What other considerations are there with a change of ownership?
There may be other considerations that you may need to understand to clearly grasp the change in ownership. In some cases there are other scenarios not listed above that may apply to you. And there may be additional filings or elections that must be taken care of in order to change ownership. Outlined below are some FAQs to further assist you.

What if the corporation elected to become an “S” corp?
The steps taken in the corporation scenario apply here, as well. However, you must keep in mind that with this type of election, there are certain shareholder restrictions. Specifically, in an “S” corp, there cannot be more than 100 shareholders. So the new owners of the corporation cannot issue stock to more than 100 shareholders.

If ownership changes, do I need a new Employer Identification Number (EIN)?
It depends. A new EIN is required only if an entity has been created. For example, if the new owner decides to start a new corporation for the existing business, then he or she would need a new EIN. If your Social Security Number was used to apply for the EIN (a requirement by the IRS), then the new owner needs to apply for a new one using his or her Social Security Number.

What if I die?
A corporation is perpetual. This means that if you as the business owner die, the corporation lives on. You should have an estate and/or succession plan that addresses what you want done with your company. An estate planning attorney can assist you with this type of document. If you as the original owner want to transfer ownership to a family member, this should be outlined in your estate plan. In addition to the estate or succession plan, all the steps addressed in Scenario 2 would apply.

In contrast, an LLC is not perpetual. The company dissolves should one of the members die. However, you can include a contingency in the operating agreement when the LLC is being formed to counteract the automatic dissolution.

Does the type of business entity matter?
Ultimately, the steps to take to transfer business ownership from one type of business to another depending on the type of business entity. Specific steps change whether the business entity is a corporation or LLC. The best course of action when dealing with the sale of a company or adding owners is to consult with legal counsel to ensure correct due diligence.

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