How Does Entity Type Affect the Sale of a Business?

Many moving parts exist when selling a business and transferring its ownership. With lots of details to wrap up before the company’s new owner can take over, the process can seem overwhelming. The steps involved in legally handing over a company to someone else can vary depending on the type of business entity, where the business is located (rules vary by state), and other factors.

In this article, I’ll touch on some of the nuances by business structure and then provide a handy checklist of common tasks to tackle when selling a company.

What Happens to Your Business Structure in a Sale?

Sole Proprietorship

Because a sole proprietorship is not a registered business entity and has no legal or tax separation between the business and its owner, the company’s assets may be sold, but not the business itself. Any remaining debts or liabilities cannot be passed on to the new owner. When a sole proprietor ceases doing business, there is no legal business entity to dissolve. However, the business owner must take care of other things to close the business and wrap up its affairs, such as canceling licenses, permits, or DBAs.

Partnership

A General Partnership is not an incorporated business entity—no legal or tax separation exists between the business and its owners (partners). However, it has more options for changing ownership than a sole proprietorship. Provided that the partnership agreement includes a buy-sell provision and not all of the core partners change, a partnership may transfer ownership percentages among members—potentially even bringing in a new partner to purchase a departing partner’s interest if all remaining partners agree. If all existing partners wish to exit the partnership, the process is the same as when selling a sole proprietorship—i.e., the partners may sell the business assets but not the company itself.

When closing or transferring ownership interests in a partnership, the partners must follow the partnership agreement's procedures, vote to approve the transaction, and file the necessary tax forms reporting the details of the ownership transfer or termination of the company.

A Limited Partnership (LP) essentially follows the same rules as a General Partnership, except an LP must be registered with the state.

A Limited Liability Partnership (LLP) is structured similar to and generally follows the same rules as a Limited Liability Company (more on that below), except that states restrict who can form an LLP.

LLC

A limited liability company (LLC) is a state-registered business entity legally separate from its owners (members). However, like a sole proprietorship or partnership, all profits, losses, credits, and deductions pass through to the business owners’ personal income tax returns. If state law and the LLC’s operating agreement and formation documentation allow it, all or part of an LLC’s ownership can be transferred through selling membership interests in the business.

In a multi-member LLC, members must vote to approve the sale or transfer of membership interests. Then, they must file Articles of Amendment to inform the state of the change in ownership. If the LLC had filed a Beneficial Ownership Information Report (BOIR) with FinCEN, it must file an updated BOIR to disclose its new beneficial ownership information.

The state's rules apply if an LLC operating agreement does not address selling the company or transferring membership interests. Generally, that means the LLC members may sell their company’s assets, but not the business itself. In those cases, the LLC must be dissolved (by filing Articles of Dissolution) and its affairs wound up.

Corporation

A corporation is a state-registered business entity legally separate from its owners (shareholders). It is also its own tax-paying entity, and its ownership shares—some or all—can be sold. Selling a corporation can be structured as a sale of stock or a sale of assets—a tax advisor can advise on which will offer the most advantageous tax outcomes.

The company’s corporate bylaws and shareholder agreement should describe the necessary requirements and approvals (e.g., shareholder and board of directors approval) for selling all or part of the company.

Seller's Checklist

While the tasks may vary depending on the entity type and other factors, here are some of the most common things that must be addressed when selling a business regardless of business entity type:

1. Establish the business’s value. Determine its worth and list the sale price of each asset.
2. Create a sales contract. Work with an attorney to write up the terms and conditions of the sale and detail what the new owner is buying.
3. Deactivate your EIN with the IRS. EINs are not transferable from one business owner to another. If the former owner has an EIN, they should deactivate it, and the new owner must request a new one.
4. File final tax forms. The former owner is responsible for their business’s tax obligations up until the time the company is legally in the new owner’s name.
5. Determine how to handle any business lines of credit. Under most circumstances, business lines of credit cannot be directly transferred. The lender may have a process for validating that the new owner meets the eligibility criteria to assume the terms and conditions of the line of credit. The former business owner might have to close their line of credit and the new owner apply for their own.
6. Communicate with customers. Give customers a heads-up that the business is closing or being sold. Terminate or update contracts accordingly.
7. Communicate with creditors. Inform creditors of the sale or closure and explain how any outstanding money owed to them will be paid.
8. Communicate with vendors. Let them know about contracts that will be terminated and those that the buyer will assume.
9. Determine how registrations and licenses must be handled. If a business has licenses and permits, DBAs, or other registrations, the parties must determine whether they can be transferred or if the former owner must cancel them and the new owner apply for their own.
10. File the necessary paperwork with the state. Articles of Amendment must be submitted to reflect the new ownership. If the business entity is dissolving, Articles of Dissolution must be filed.
11. Submit an updated Beneficial Ownership Information Report. If a company has previously filed a BOIR, it must issue an updated report with the new beneficial owners’ details.
12. Pay remaining bills. The former business owner should resolve any outstanding bills incurred until the new owner assumes responsibility for the company.
13. Distribute any assets remaining in the business. For accounting purposes, the sale of a business is usually not handled as the sale of a single asset. Instead, each asset is documented as a separate sale and classified appropriately (e.g., as capital assets, inventory, depreciable property, or real property) to determine how gains and losses should be reported.
14. Pay final wages to employees. The seller of the business is responsible for compensating their employees (and any subcontractors) until the date the new owner takes over.
15. Transfer business bank accounts. With LLCs and corporations, business accounts may usually be transferred to the new owner, provided the parties follow the financial institution’s process and supply the required documentation to verify the change in ownership.
16. Tend to business insurance policies. Depending on the insurance company and other considerations, it may be possible to transfer business insurance to a new owner. The former owner should cancel any insurance policies not assumed by the buyer.

Before You Sell Your Business...

To ensure all i’s get dotted and t’s crossed, it’s wise to consult professionals—like an attorney, accountant, and business valuation specialist—to ensure no loose ends unravel your best-laid plans. No two businesses' situations are exactly the same, so getting focused expertise from trusted advisors who can guide you on what you must do is absolutely essential for a smooth and successful transfer of power.