Outside Sale
Because of the legal and tax issues involved in the sale of a business or an ownership interest in a business, most successful sales involve the assistance of an attorney, and a certified public accountant.
If the buyer insists that he or she only purchase selected assets of the business, rather than purchase the owner's interest in the business, the selling business needs to pay close attention to the evaluation placed on the assets sold, with those assets falling within the tax category of "capital assets" receiving the highest possible value. The sale of capital assets are taxed at a lower rate than the sale of "ordinary assets". Usually, the selling business dissolves after the acquisition of most of its assets, which means that all creditors are paid, and the owners receive distributions of the remaining assets. The IRS considers dissolution to be a taxable event, taxing the difference between the owner's basis in his or her ownership interest, and the fair market value of the assets received as the final step in the dissolution process. Consequently, It is important to maximize all deductible expenditures before making the distribution to owners and filing the final tax return.
Dissolution is a process that is governed by statute, and begins by the filing of "Articles of Dissolution" with the office of the Secretary of State.
If the buyer wishes to purchase the owner's interest in the business for cash, the transaction can be less complex than the sale of selected assets, but the issue of undisclosed liabilities often raises issues not faced in the purchase of selected assets. Sometimes, the buyer will ask the seller to personally guarantee any liability not disclosed on the company's balance sheet. Sometimes, the buyer will insist that some part of the purchase price not be paid until a later specified time to cover any undisclosed liabilities that come up after the sale.
If the seller is asked to sell his or her interest on an installment method, the seller must put on the hat of a banker. As a security interest is taken in the ownership interest in a business by pledge of the certificate memorializing ownership issued by the business, the "Purchase and Sale Agreement" should provided for escrowing of the certificate. Limitations on the buyer's salary and fringe benefits, until the buyer is paid, may also be appropriate.
Internal Sale
By internal sale is meant the purchase of an owner's interest in the business by another owner or by the business entity. The events that can trigger the sale or purchase of the interest are the owner:
(1) dying
(2) becoming disabled
(3) prematurely terminating his or her relationship to the business
(4) reaching an agreed upon age.
In a corporation, the document memorializing the agreement between owners is often called a "shareholders' cross purchase agreement". The document memorializing the agreement between the owners and the corporation is often called a "corporate redemption agreement".
In a limited liability company, the document memorializing the agreement between owners is often called a "members' cross purchase agreement". The document memorializing the agreement between the owners and the limited liability company is often called a "limited liability company redemption agreement".
The evaluation of the value of the owner's business interest in such agreements can be quite complex, and different values can be agreed upon depending upon the event that will trigger the purchase and sale of the interest. For example, the value in case of death may be significantly higher than the value in case of reaching an agreed upon age. In the case of death, there may be life insurance death benefits payable to the buyer to use to pay the estate of the deceased owner. In the case of an owner reaching a certain age, the payments will have to come from the after tax income of the buyer, whether the other owners or the entity.
Often, an owner has an employment agreement with the entity that can only be terminated by the entity for cause, or by him or her at will. The internal sale agreement then says that termination of employment is an event triggering the sale and purchase of that owner's interest in the business.
Non-competition provisions are often appropriate to prevent the owner whose interest is being purchased from diminishing the on going concern value of the entity by competing against it.