Three Steps to Take After Closing

The sale of one’s business can take many months of preparation and stressful negotiations before the actual closing occurs. Many sellers of businesses do not realize though that they must still take a few key steps after the sale in order to fulfill their obligations to the buyer and shield their legal and tax liability. Three key steps the seller should take after the closing are completing the transition of the business to the buyer, dissolving their corporate entity, and exploring how to save capital gains taxes.

Step One: Complete Transition

Most buyers of businesses will require the seller’s assistance after the sale in order to effectuate a smooth transition (or handover) of the business. The level of involvement by the seller in the business will determine the degree to which a buyer will require the seller’s assistance after the closing. If the seller had a high degree of involvement in the business and a personal relationship with the company’s vendors, employees, or customers, then the buyer will insist that the seller stay with the business after the sale for a lengthy period of time.

Free Transition Period

Most business sellers will agree to give two to four weeks of free training after the sale occurs. The amount of free training a seller is willing to provide should be told to the business broker prior to listing the business, and should be advertised as such to the general public. The buyer should usually expect the seller to work an average 40 hour work week during the free transition period. The purpose of the free post-closing transition period is to familiarize the buyer with the internal workings of the business, as well as introducing the buyer to key customers, vendors, and employees.

Paid Transition Period

Sometimes, the free transition period is simply not enough time for the buyer to feel comfortable with taking over the business. The buyer may feel that the seller’s participation after the closing is so instrumental that the buyer will want to hire the seller for a period of time at a negotiated rate after the free transition period. The buyer should always make their post-closing intentions clear in their offer so that the seller can properly respond. The more that the buyer needs the seller’s help and cooperation after the sale, the more likely it is that the buyer will seek to hire the seller as a paid employee or consultant after the free transition period.

Step Two: De-Active Seller’s Corporate Entity

In the vast majority of business sales, the buyer does not actually purchase the seller’s corporate entity (such as a corporation or limited liability company). Instead, the buyer purchases the business via an asset purchase deal. In an asset purchase deal, the buyer will create their own corporate entity and buy the assets (both tangible and intangible) of the seller’s corporate entity. After the closing, the seller’s corporate entity should thus be de-activated with the Florida Department of State on sunbiz.org. This is a simple process whereby the seller formally notifies the state of Florida that their corporate entity is dissolved by filing an Article of Dissolution. Once dissolved, the seller will avoid any ongoing liability from owning an active corporate entity.

Exception: Stock Purchase Deal

Sometimes the buyer does not use an asset purchase deal when purchasing a business.
Instead, the buyer will use a stock purchase deal.
A stock purchase deal is where the buyer purchases the shares or membership interests in the seller’s corporate entity.
The buyer will not create their own corporate entity and instead be the new owner (or shareholder) of the seller’s corporate entity.
A major drawback with a stock purchase deal is that the buyer inherits the liability of the seller’s corporate entity.
Such deals mainly occur in the healthcare industry, where buyers covet the licenses and insurance contracts held by the seller’s corporate entity.
Sellers do not de-activate their corporate entity when selling their business via a stock purchase deal, but still must assure that the Florida Department of State is informed of the change in ownership via sunbiz.org.

Step Three: Explore Tax Savings

Some sellers of businesses may face large capital gains taxes after the sale of their business. The maximum long term net capital gains (after the capital basis is deducted from the seller’s net proceeds) is 20%, but may change at any time. By taking a seller-financed note or by receiving at least part of the purchase price through post-closing consultancy or employment fees, a business seller may avoid some of this immediate tax burden. At the minimum, a business seller must be aware of their potential capital gains tax liability and be prepared to pay such taxes after the closing occurs.

Using Section 1031 Exchanges

The most effective way of deferring (indefinitely) capital gains tax liability is through a 1031 Exchange. This refers to deferring capital gains taxes on qualified investment or business assets by swapping like minded properties within 180 days of the original sale. Real estate property used by the business, corporately owned personal property (such as vehicles), and quantifiable franchise rights or ‘lines of business’ all qualify as allowing a 1031 Exchange. The problem is that the ‘goodwill‘ of a business does not qualify as allowing a 1031 Exchange, and goodwill frequently constitutes a large part of the value of most business. With the advice of a good tax attorney or accountant, however, business sellers may still use 1031 Exchanges in order to defer much of their capital gains tax liability.

Business sellers should be aware that their responsibilities do not end with the business sale. They still must properly transition the business over to the buyer and properly dispense of their corporate entity. Moreover, every smart business seller should do everything possible after the sale in order to avoid paying overly burdensome capital gains taxes.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.