How to Transfer Business Ownership Percentages
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It’s not unheard of for the ownership of a small business to shift with time. Sometimes the reasoning may be as simple as the business is growing and it needs to take on more partners. Other times the business is being prepped for sale or being passed along to a family member or successor.
No matter the unique circumstances, it’s important to know how to change the percentage of ownership in a corporation. Although the temptation is to enter a new or existing partnership with a handshake and informal agreement, these aren’t best practices and could hurt all parties and the business in the long run.
What is an ownership percentage?
Ownership percentage is the percentage of the company that each partner owns. This percentage is used to calculate ownership and profit distributions at the end of every quarter. Ownership percentage is typically reflected by how many “shares” each business partner owns. The number of shares each partner owns, as well as how the shared ownership of the business works is spelled out in an operating agreement that can be drawn up by an attorney and will be signed by every owner of the business.
With an attorney, business owners establish a set number of shares that comprise the entire value of the company. Then, each business owner is given a number of shares based on the percentage of the business they own. These shares lose and gain value depending on how successful the business is and determine the amount of profit distributed to the owners at each set period. Before buying into a business, it can be helpful to work with both an attorney and a business valuation company to help determine the value of each share within the organization before creating an operating agreement.
Reasons to change ownership percentages
There are several reasons to be interested in changing ownership percentages in a business.
First, it may be a natural time of growth in the business and it’s looking to bring on more partners as a result. In this case, the company should be valued, and an operating agreement that outlines:
- What each partner is expected to contribute to the company
- What responsibilities fall under their jurisdiction
- What percentage of profits each partner is entitled to
- How partners will be compensated
- How taxes are handled within the business
Adjusting ownership percentage among current partners
Is there an existing partner who would like to own a larger percentage of the company? Does one partner wish to scale back ownership as they near retirement, and shift a higher percentage to another, more actively engaged, partner? Many times, ownership percentages are adjusted as a result in a shift in the amount of work each partner is putting in, or based on how much capital they’re investing into the business. To accomplish this change, speaking with an attorney about making the adjustments in the operating agreement is a necessary first step to protect everyone’s interests.
Selling a business
If a private business is looking to sell, this qualifies as a change of ownership percentage. Typically, buyers either purchase the business outright either in cash, through a small business loan or bank financing. Additionally, the owner of the business can participate in an owner-financed sale where the buyer pays the owner in installments until they fully buy the business.
Even if a business is sold to a family member, a formal partnership agreement that indicates the transfer of percentage of ownership to the new business partner will need to be created.
How to transfer business ownership percentages
The way that the ownership percentage of a business is adjusted will largely depend on the legal structure of the business. For example, a sole proprietor or an LLC (taxed as a sole proprietor) may need to start from scratch and create an operating agreement before moving forward with a new partnership. However, an S-Corp or C-Corp will already have an operating agreement in place and will need to take a few additional steps to change ownership percentages.
Undergo a formal valuation.
Having the business valued by a valuation company can give an honest view of what the business is worth, what each share is worth, and how to fairly divide shares among all partners.
Create a stock purchase agreement.
If one of the business partners wants to increase the percentage of the company they own, a stock purchase agreement can help them gain more shares without decreasing other partners’ ownership percentages. Or, if all of the shares in the company have been distributed to each partner, the partner wishing to increase their equity share can consider purchasing a portion of another partner’s shares to increase the ownership percentage.
Update the stock ledger.
Whenever a change of company ownership occurs, it needs to be reflected in the stock ledger.
Update the articles of incorporation.
Legally, anytime there is a business ownership change, an update to the articles of incorporation is required and they need to be re-filed with the state in which the company is registered. If this is not done, a court of law could technically “pierce the corporate veil” to investigate the business, which can put all the partners personally liable for any business debts or future legal fees owed.
Considerations when changing ownership
If the business has been owned by a single owner for some time, bringing on additional partners, or going through a buy-out process can feel financially overwhelming. While there are many things to consider, it’s important that all parties are actively working to protect their own interests. This includes the impact that taxes will have on profit distributions among business owners in a partnership.
“Generally, whether you have an LLC or an S-Corp, operating agreements are poorly written. Many business owners find a template online to use and leave it at that. These agreements don’t always address distributions, which can impact the individual business owners and how much they’ll owe each quarter in taxes,” said Anthony Baldassano, CPA/PFS, and founder of Anthony & Associates Certified Public Accountants, LLC.
Business owners are each taxed on the percent distribution they take of the business’s profits each quarter. For example, if the business profits $100,000, the business pays taxes on those profits. However, if a business owner is paid out 30 percent of the $100,000 profits, they’ll individually owe taxes on $30,000.
“There needs to be some verbiage in the operating agreement that acknowledges taxes on profit distributions,” Baldassano said.
Finally, business owners looking to change their ownership percentage because they’re working to leave a business or partnership, or pass the business on to someone else, need to determine the value of their business before taking any additional steps to change ownership percentage.
“Operating agreements are notoriously vague when it comes to the value of the business. They often determine the value of shares based on ‘fair market value,’” Baldassano said. “A lot of partners get in trouble here, and they end up having to bring lawyers in to determine what each partner is owed – especially if the separation isn’t amicable.”
This kind of uncomfortable conflict can be prevented by going through a business valuation process on the front end of changing the ownership percentage. Even if the new partner is a friend or family member of the owner or existing partners and everyone believes things will be fair, it’s in everyone’s best interest to create a formal operating agreement. This will prevent hurt feelings or lost money if the partners choose to add new partners, leave the business, or dissolve any existing partnerships in the future.
The bottom line
At the end of the day, transferring business ownership percentages isn’t something that should be taken lightly. In running a small business, it’s common to overlook the legal and financial necessities. Often this isn’t through any personal fault as a business owner, but simply “not knowing what you don’t know.” However, changing ownership percentages in a small business is not a process that should be carried out by amateurs. Instead, find professional help.
Whether a new business partner is being added, or a partner’s shares are being sold, both legal and financial protection are needed. Speaking with an attorney, business valuation company, and an accountant can help ensure that all areas of the ownership percentage change to do list are covered, while protecting everyone against potentially negative outcomes both now and in the future.