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?
When starting a new business, one of the most important decisions you will make is what type of business structure to use. Among the various options available, the S corporation (S-corp) is one that many small business owners consider. In this article, we will explore what an S-corp really is, how it works and what benefits and drawbacks it offers to businesses.
What is an “S-Corp?”
An S-corp is not an entity type, but rather a type of tax election and classification that allows small businesses to avoid the double taxation that can occur with a regular corporation. Both a corporation and a limited liability company (LLC) may elect to be taxed as an S-corp. This tax status is granted by the IRS, and a business must meet certain requirements to be eligible for it. To qualify as an S-corp, a business must meet the following criteria:
1. The business must be a domestic entity.
2. The business must have only type of owner, which are generally individuals, estates and certain trusts.
3. The business must have no more than 100 owners.
4. The business must have only one class of stock (or membership interest for an LLC).
How Does an S-Corp Work?
An entity that has elected S-corp tax status is a pass-through entity, which means that the business's income, deductions and credits flow through to the owners' individual tax returns. This avoids the double taxation that can occur with a regular corporation, where the corporation pays taxes on its profits and the shareholders pay taxes on their dividends.
When an S-corp earns income, it is distributed to the owners in the form of dividends. The owners report these dividends on their individual tax returns and pay taxes on them at their individual tax rates. The S-corp itself does not pay federal income tax, but it may still be subject to state and local taxes. One important thing to note about S-corps is that owners cannot deduct losses that exceed their investment in the company. This means that if an S-corp has a loss, owners can only deduct their losses up to the amount of their investment in the company.
Benefits of an S-Corp
There are several benefits to operating as an S-corp:
1. Pass-through taxation: The biggest advantage of an S-corp is that it avoids double taxation. Since the business's income, deductions, and credits flow through to the owners' individual tax returns, there is no need to pay taxes on both the business and individual levels.
2. Limited liability protection: Like a regular corporation, an S-corp provides limited liability protection for its owners. This means that the owners are not personally liable for the debts and liabilities of the business.
3. More favorable tax treatment: S-corps can offer more favorable tax treatment than other business structures. For example, S-corp shareholders can take advantage of the qualified business income deduction, which allows them to deduct up to 20% of their share of the business's income.
4. Flexibility in ownership: S-corps can have up to 100 owners, which allows for more flexibility in ownership than some other business structures. This can be particularly beneficial for businesses that want to bring on additional investors or employees.
Tax Benefits of S-corp Status for LLCs.
An LLC taxed as an S-Corp may also save on self-employment taxes. This is because the owner's salary is subject to payroll taxes, but the distributions they receive are not. And once an owner receives a “reasonable” salary for the tax year, the remainder of profit may be distributed as a dividend and only subject to regular income tax. See next tip section for more information.
Drawbacks of an S-Corp
While there are many benefits to operating as an S-corp, there are also some drawbacks. S-corps are subject to more paperwork and record-keeping requirements than some other business structures. For example, S-corps must file an annual tax return, and they must keep careful records of their owners' ownership percentages.
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 contrast, 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
Incorporating Out of State
It is a popular misconception that incorporating (or organizing) a new business in states like Delaware, Nevada and Wyoming is advantageous for various reasons, including tax savings. While there are occasionally good reasons to incorporate out of your home state, in a majority of cases incorporating in the state where the business will primarily be doing business makes the most sense. First, taxes can be complicated but generally the business and/or its owners will pay taxes in the state where the income is earned, and not in its state of incorporation. Second, the business would still have to register to do business in the state in which it is operating. That means that the business would be paying registration fees in two states instead of just one. Last, incorporating in a different state would subject the business to being sued in an additional location.
Use.
For most businesses, this is not a major issue because they are simply occupying the office space for “general office” use. Tenants who need non-traditional space, such as a restaurant, should pay careful attention to permitted uses. Any specific use requirements should be set out in the use provisions to make sure that the landlord allows the tenant to properly utilize the space.
CAM / Operating Expenses.
Almost all commercial leases require the tenant to share in the expenses of maintaining the common areas and operating the building. Make sure that the tenant’s share is an accurate ratio of leased square footage compared to the total square footage of the building, complex, project, etc. Landlords will sometimes try to include only leased portions of the building or project in the equation, which can greatly increase a tenant’s proportional share of the expenses. Lastly, confirm that shared expenses are limited to those reasonably incurred for the benefit of the building or project and not other buildings or projects the landlord may own or operate. Lastly, try and obtain a cap on the annual increase.
Insurance.
Most leases will set out certain required insurance coverage that tenants must maintain during the lease term, including worker’s compensation and general liability insurance. The lease will set out minimum amounts of coverage, and the landlord will often have to be named as an additional insured. Tenants should verify that they will be able to obtain such insurance coverage or else negotiate the requirements to a level at which they can.
Repairs / Utilities.
Tenants should be cognizant of what repairs they will be required to make during the lease and which utilities it will have to pay. Most commercial leases require that the tenant make repairs, but complications can arise when multiple tenants share space in the same building or project. In addition, tenants who are responsible for replacing equipment should be aware of the potential cost of having to replace major equipment and machinery like HVAC units, especially near the end of a lease term.
Assignment / Subletting.
A majority of commercial leases require consent from the landlord for the tenant to assign any part of a lease or sublet any part of the space. Tenants should try and at least require that the landlord not withhold its consent unreasonably. Further, landlords will often place specific restrictions regarding to whom a tenant may sublease. Common examples are minimum financial condition, type of industry and parking needs.
Default Remedies.
Some of the most lopsided terms of a commercial lease are provisions that dictate what steps a landlord can take upon the default of the tenant. In Georgia, landlords are generally required to file a dispossessory (eviction) action with the local courts. This gives the tenant the option to fight the proposed eviction in court. Most commercial leases will have a provision that waives this right and permits the landlord to simply change the locks and take over the space if the landlord determines that there has been a default. Many businesses could not survive this type of shutdown. Having to sue after the fact is never as good as preventing the problem beforehand.
Substitution Space.
Many commercial leases allow the landlord to shuffle tenants around to different space as long as that space is “comparable” to the original space. Tenants should make sure any substitute space will be adequate for their particular needs and limit any increase in square footage when it is not needed but would have to be paid for. Also, tenants should try and have the landlord pay for all reasonable moving expenses incurred due to the substitution.
Rules & Regulations.
It is common for landlords to have somewhat minor provisions called rules and regulations that can be modified by the landlord from time to time. Any party to a contract should be leery of any provision that allows the other party to arbitrarily modify any term of the agreement at some point in the future. While many of the rules and regulations will be relatively minor, they may include some terms that may be vital to a small business such as addressing, signage and parking. In addition, tenants should look out for soft, amorphous language like “character of the building” or “reputation of the complex.” These terms have little objective meaning and are too subjective for a good, clean lease.
Common Issues in Commercial Leases
Contractor vs. Employee
How an employer defines the relationship that exists when someone performs services can have a large impact on the way a business operates. A person performing services might be an independent contractor, a statutory employee, a common-law employee, or a statutory non-employee. An employer generally must withhold income tax, withhold and pay social security tax, and pay unemployment taxes on wages paid to an employee. A business does not usually have to withhold or pay taxes on money paid to independent contractors.
Misclassification of the employer-employee relationship is a prime area for IRS enforcement. The IRS has targeted the “contract labor” category of payment as one which is easily and frequently abused. They are taking a serious look at anyone classified as “contract” to determine whether they have been mis-classified and should be considered an employee.
If someone is truly an independent contractor, the business contracting for services must provide a 1099-MISC. to the individual if they were paid more than $600 in the calendar year. This is the “Statement to Recipients of Miscellaneous Income,” and copies must be filed with appropriate state and federal agencies, similar to a W-2.
The employer should also be aware that most states have separate sets of guidelines on what constitutes an employer/employee relationship. Frequently these differ from those of the federal government. You should review both sets of applicable criteria when deciding how to classify a worker. If you believe that your situation is unclear after reviewing the materials, you may complete Form SS-8, and the Internal Revenue Service will make the determination for you.
Using independent contractors can be a good business decision and can save employers money in payroll taxes, employee benefits, and workers compensation costs. Nonetheless, it is worthwhile to be careful since mistakes can be costly. An employer must have a reasonable basis for treating a worker as other than an employee. If you do not have a good reason for doing so, you may be subject to large fines and back taxes.
What is a Trademark, exactly?
A trademark is a word, phrase, symbol or design, or a combination thereof, that identifies and distinguishes the source of the goods of one business from those of another. (A service mark is the same as a trademark, except that it identifies and distinguishes the source of a service rather than a good.) Copyrights and patents protect different types of intellectual property. A copyright protects an original artistic or literary work, and a patent protects an invention.
When a qualifying trademark is first used in commerce and in a geographic area, it automatically receives common law rights is that area. It is often designated with a “TM” subscript (or “SM” for a service mark). Business names, taglines, product names, logos, design elements and sounds used to identify businesses are all covered by a common law trademark. Common law trademarks may preclude competing businesses in an area from using identical or similar marks that could cause confusion among customers. Common law trademark rights are limited to the geographic area where it is being used (and areas where it could reasonably expand). That is why some businesses choose to registered their trademarks on a national level with the U.S. Patent and Trademark Office (USPTO).
To qualify for a federal trademark registration with the USPTO: 1) you must use or intend to use the mark in commerce and 2) the mark must be distinctive to your business. If you see an “®” at the end of a logo, word or phrase, that likely means the trademark has been registered with the USPTO. Whether it is best to register a trademark with the USPTO or protect it under common law rights depends on the trademark, the business itself and other details such as intended use, future of the business and the potential value of the trademark.
Which Employees are Exempt from Overtime?
Under federal law, exempt status is determined by the Fair Labor Standards Act (FLSA). Exempt employees are not entitled to overtime, while non-exempt employees are. In order to qualify as exempt, certain criteria must be met.
Non-exempt employees must be paid at least minimum wage plus overtime if they work more than 40 hours in a work week. Overtime must be paid at 1.5 times their regular pay rate. You may also need to comply with state labor laws in the state where the employee works. Employees are considered non-exempt unless they qualify for an exemption.
Exempt employees are covered by the FLSA nut are not entitled to overtime pay (and not subject to the minimum wage). Most exempt employees work in upper-level, executive, professional and administrative positions. Some occupations are classified by definition as exempt, such as attorneys, other professionals, teachers and outside sales reps. Exempt status is considered advantageous to employers because it does not limit the hours that employee may legally work in a given pay period. Exempt employees often work more than the standard 40-hour week. More information can be found here.
There is also a salary minimum for an employee to qualify as exempt. The current threshold is $684 per week, but will likely to increase in the near future. The increases are reviewed and modified every 3 years.