Selling your business:
Thousands of small businesses change hands every year, but often not enough money is left in the hands of the seller. As such, we would like to share some advice about preparing your business for sale.
- Have an exit plan. Most entrepreneurs have start-up plans and growth plans, but too many fail to prepare for the time when they want to sell the business or reduce their day-to-day involvement.
- Know the market value of your business. Know the value in the world marketplace. Simple formulas are often misleading and are inaccurate measures of the value of a private business.
- Explore ways to increase value. A business could be made more attractive to prospective buyers if changes are made in the organization, key personnel, or marketing strategies.
- Understand when the market is ready. Be ready when buyers are active, money is plentiful, and interest rates are low.
- Don’t assume the best buyer is local.
- Document the growth potential of your business.
- Consider which perks you’ll miss after selling your business. Usually the transaction can be structured to retain those executive perks which you enjoy while meeting the buyer’s needs.
In addition to implementing these tips, be sure to work with a competent business attorney and tax professional. This is not a time to skimp on professional help.
What does "S-corp" really mean?
The term "S-corp" is often used to describe an entity type - usually a corporation. The truth, however, is that the terms "S-corp," "Subchapter S corporation" and the like really refer to a tax election / classification. A small business set up as a corporation will typically elect to be taxed as an S-corp instead of the default tax status of a "C-corp" to avoid double taxation - being taxed on revenue when it comes into the corporation and then again when money is paid out to the shareholders.
Whereas with S-corp status taxes are only paid once (pass-through taxation) - when money is paid out or otherwise allocated to the shareholders. But keep in mind that both a corporation and an LLC can be taxed as an S-corp - see next section below.
LLC v. S-corp:
As described above, both corporations and LLCs may be taxed as an S-corp. But for purposes of this section we'll assume we are comparing an LLC that has not elected to be taxed as an S-corp and a corporation that has. And since they both have pass-through taxation - where taxes are only paid once when money is distributed - what is the difference?
The primary difference is the employment tax that is paid on earnings. The owner of an LLC is considered to be self-employed and, as such, must pay a "self-employment tax" of 15.3% which is applied to Social Security and Medicare. The entire net income of the business is subject to self-employment tax. In contract, an S-corp is able to pay out funds as stock dividends, which are not subject to the self-employment tax. But keep in mind there are restrictions such as the requirement that a "reasonable" salary be paid first before dividends may be paid.
A comparison chart is a good summary of the similarities and differences between the two business structures:
Characteristics S Corporation LLC
Liability Protection: Yes Yes
Operational Control: Board of Directors/Officers Flexible / Owners' Choice
Federal Income Tax: Pass-through Pass-through
Flexibility/Ease of Operation: No (rigid corporate formalities) Yes
Ownership Restrictions: Yes (e.g. one class of stock) No
Flexibility in Profit-Sharing: No Yes
Employment Tax: On salary only On net income