How to Transfer Business Ownership: What You Need to Know

One way to realize the American dream is to start a business, become wealthy and eventually sell the business for a nice profit. When the time comes to do the latter, though, you’ll need to transfer business ownership.

There are several methods of transferring business ownership. The method chosen depends on the business owner's needs and plans, the market and the structure of your business.

How to transfer business ownership

Briefly, business owners can:

When considering how to transfer business ownership, you should realize that ownership transfers have legal and financial ramifications that vary by the type of transaction and the type of business structure. In general, owners need to consult lawyers and accountants to ensure that all appropriate steps are taken and correctly executed.

Let’s look at the methods of transferring business ownership in detail.

Sale of business

If the business is private, a business valuation needs to be performed so that both the owner and seller agree on the price, either for the whole business or the portion to be sold.

You can sell a business with:

Reapportion ownership among multiple owners

Both partnerships and limited liability companies (LLCs) may have two or more people with an ownership stake.

Partnerships are generally guided by a partnership agreement, which may allow or restrict transfers of partnership interest. Partners must follow the terms of the agreement. If the agreement allows it, a partner can transfer ownership stakes in terms of profits, voting rights and responsibilities. If there is no partnership agreement, the laws of the state apply.

If partners change, the partnership will be considered legally dissolved and will need to be reformed.

In the case of an LLC, owners are called "members" and pay for an ownership percentage. Most LLCs are governed by operating agreements and articles of organization, and these documents set forth the terms of any transfer of ownership. In addition, all other members must agree to a transfer and transfers need to follow state law.

Lease-purchase

In a lease-purchase, the lessee leases and runs the business for the lease period. Lease-purchases can work effectively if the lessee wants to test out the business before purchasing it. At lease end, if the lessee wants to buy the business, the owner can transfer it via a sale or a lease-to-purchase deal.

Transfer via gifts or bequests

If you want to slowly give your business to an individual over time, you can avoid gift taxes by doing so in $15,000 annual segments (per individual) up to a lifetime maximum of $11.7 million for 2021.

You can also transfer the business to a beneficiary named in your will or in a legally binding succession plan, for a transfer to take place upon your death.

If a family member is your beneficiary, the estate will be subject to tax if the value exceeds $11.7 million, the exemption amount for 2021.

How your business's structure affects transfers of ownership

These four basic methods of business transfer apply to all businesses. The business structure, however, affects multiple operating, financial and legal issues.

1. Sole proprietorship

By definition, a sole proprietorship has just one owner. Thus, a business owner can’t really sell a sole proprietorship, although they can sell its assets. The sole proprietorship dissolves as a result, and the buyer can use the assets (or rights to the liabilities) in any new type of business structure.

You will need to value your business to determine a sale price for the assets. A sales contract should be created, showing the amounts paid for each asset. Normally, no state filings are involved in this type of transaction.

As an example, Joe runs a successful woodworking shop as a sole proprietorship. He wants to retire and finds someone willing to buy his equipment, his company name and his customer list. The book value of the assets is $45,000, and the buyer is willing to spend $60,000 for the purchase. Joe and the buyer execute a sales contract to memorialize the sale.

2. Partnerships

State regulations on partnerships vary, so the partnership might have to file forms with the state government declaring any ownership change.

Let's assume that Joe, Bob and Jill are equal partners in their woodworking business. Joe is retiring and will distribute his 33.3% stake in the company's $60,000 of capital equally to Bob and Jill, as per the operating agreement. The company has earned $90,000 for the year as of the date of ownership transfer. Joe receives $30,000 in income and another $20,000 for his share in the business's capital. The operating agreement is updated to show a 50%/50% ownership by Bob and Jill, and a new partnership filing is made with the state. The annual Schedule K-1 (Form 1065) tax forms required of partnerships will reflect the income distributions resulting from the ownership transfer.

3. LLC

If the woodworking company owned by Joe, Bob and Jill had been set up as an LLC, the procedures followed at Joe's retirement would be roughly the same. However, ownership would be transferred by Joe selling his stake to Bob and Jill.

The LLC draws up a new operating agreement and articles of organization, filing with the state if required.

4. Incorporation

Businesses can be incorporated as either a C Corporation or an S Corporation. In both, ownership percentage is based on the shares owned. If you want to transfer ownership, the process is the same for both. Shares can be sold, gifted or bequeathed. An S Corporation cannot have more than 100 shareholders, so transfer of ownership may be prohibited if it would create more than the allowable number of owners.

If you want to transfer ownership of all or part of your stock in a corporation, you may need to seek approval from the board of directors and other shareholders.

After that, you should consult with both an attorney and tax advisors to determine the optimal method and timing of selling your shares, to both maximize your proceeds and minimize your taxes.

For example, Three Woodworkers Inc. has 900 private shares split equally between Joe, Bob and Jill. Bob and Jill agree to buy Bob's 300 shares (150 each) for $200 per share, and the transfer is recorded in the corporation's books and records. Bob records a long-term capital gain of $50 per share on the shares he sells, and he pays capital gains tax on those shares.

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