Guidelines for Selling a Business

In the movie, "Schindler's List", Oskar Schindler commented to his accountant: “My father was fond of saying you need three things in life – a good doctor, a forgiving priest, and a clever accountant.”

I'll discuss two of the three.

The Role of Your Attorney

In selling your business you'll need to have a sales contract prepared spelling out the rights and obligations of each party to the contract. You would be wise to use the services of an attorney to prepare the contract to ensure your interests are served.

Installment Sale:

If you sell your business on an installment basis, the services of an attorney will be particularly important because of the inherent risk of extending credit. For example, your attorney will include in the contract your legal recourse should the buyer default.

In an installment sale, your attorney may prepare a conditional sales contract where you retain title to all property transferred in the sale until you receive final payment.

A promissory note will have to be prepared indicating payment terms.

An additional concern of yours, if the sale is an installment sale, will be the buyer's experience in operating the type of business he/she is buying. Lack of experience may lead to business failure causing the buyer to default on the payment obligations.

A wise move would be to get a substantial nonrefundable down payment before agreeing to an installment arrangement. This way, if the buyer defaults, you at least received something out of the deal and can move on to try and sell your business once again.

Outright Sale:

If you're not willing to personally carry the note on the business and would prefer an outright sale, your main concern will be the financial qualifications of the buyer. Does the buyer have the money or ability to borrow what is needed to buy your business?

Of course the won't be known until you do some checking. Discuss a strategy for quickly screening out empty barrels with your attorney. You must find out as soon as possible if the prospect is financially capable to buying the business.

Do not release any financial information on your business until you are satisfied that such person is a serious player.

Business Brokers:

If you don't mind paying a commission to a business broker to help sell your business, a business broker may be a good idea. You may be able to sell your business much faster since they generally have a list of potential prospects that have been screened and are searching for all kinds of business opportunities.

However, because a business broker will want you to sign a contract to engage his or her services, it would be a good idea to have an attorney review the contract.

Documents Your Attorney May Prepare:

Your attorney may prepare a variety of documents for you. For example:

A sales contract:

A sales contract will include the rights and obligations of buyer and seller. A conditional sales contract may be prepared whereby you, the seller, retain legal title to property transferred until the installment collections are completed.

Promissory note:

If it's an installment sale is agreed upon, a promissory note will have to be prepared indicating the payment terms. For example, the amount to be financed, the interest rate, when payments will commence, the number of payments to be made. the frequency of payments (weekly, monthly).

Security agreement:

A security agreement contains a description of all property included in the sale. You, as the creditor, have a secured interest in thel property included in the security agreement. You generally have no security interest in property not included in the security agreement.

The security agreement gives you the right to repossess property if purchaser defaults.

Financing statement:

The financing statement perfects your security interest in the property included in the security agreement. In other words, if rival creditors make claims against the same property, you will have a superior interest.

Generally the above documents are typically prepared when selling a sole proprietorship. There may be other documents required to complete the transaction depending on the rules of your state. A competent attorney will guide you through the process.

The Role of Your Accountant

One of the many important services your accountant can provide when you're ready to sell your business is helping you set a price for your business. For example, one approach for setting a price is based on some multiple of your annual net income (e.g., 10 times net income).

Regardless of how you go about setting a price for your business, what is important to a potential buyer is being able to justify the price you're asking.

A serious prospect will want to see your books and records, financial statements, tax returns and any objective information to corroborate the information reported in your books, records, and tax returns.

Questions will be asked. You'll want to be responsive to the prospects questions and concerns or risk frustrating the prospect and losing the sale..

Your accountant will help ensure that the prospect has all his financial and tax questions answered and that requests for financial information are met on a timely basis. By satisfying the needs and concerns of the prospect in a timely manner you'll be more likely to achieve your goal of closing the deal to your satisfaction.

If you enter into an installment sale, your accountant will set up a payment schedule (an amortization schedule) which will show the terms of the deal, the total monthly (or whatever payment period was agreed to), the portion of the each monthly payment that represents and principal..

At year end, the amortization schedule will be used to determine the annual interest income you must report on your tax return. You will also need to know the amount of gain to recognized each year on the installment payments received.

Your accountant will also help to ensure that your tax obligations are met to keep you out of trouble with the IRS and avoid costly penalties for noncompliance with the rules..

After all, once you receive that bundle of cash from selling your business, you won't want any tax problems to surface in the future due to some compliance failure.

Accounting and Tax Services You May Need:

Here are some of the services your accountant can provide:

  • Determining a selling price for your business.
  • Reconciling bank accounts.
  • Assistance in performing an inventory of merchandise held for sale to customers, used in manufacturing, as well as office supplies.
  • Preparing an itemized list of equipment, furniture, and fixtures included in the sale.
  • Identifying any intangible assets (section 197 intangibles) included in the sale, such as franchises, trademarks, trade names, customer lists, and patient lists.
  • Recording all the necessary bookkeeping entries to bring your books up to date.
  • Preparation of financial statements (income statement, balance sheet). A serious prospect will want to see this information.
  • Preparing Form 8594, Asset Acquisition Statement.
    • The selling price of your business must be allocated to the property included in the sale.
    • The property included in the sale must be placed in specific asset classes indicated on Form 8594.
    • As the seller, your gain on each asset class is based on the values included on Form 8594.
    • The purchaser's basis for the property transferred is shown on Form 8594.
    • Determining your tax liabilities.
  • Preparing a payment schedule if the sale was an installment sale.
    • This schedule will show:
      • The amount financed
      • The interest rate
      • Number of payments to be made
      • The amount of each payment, broken down by interest and principal
      • The remaining principal balance after each payment.

Your Role in Selling Your Business

In addition to legal and accounting services that may be needed when you sell your business, you will have certain responsibilities to attend to as well.

Eight things you may need to do:

1. Notify your creditors:

The Bulk Transfer provisions of Article 6 of the Uniform Commercial Code and the Bulk Sales Acts (a class of statutes to protect creditors) both address notification to creditors of an impending sale of inventory sold in bulk and not in the ordinary course of business.

These notification rules generally do not apply to service businesses because the sale of merchandise is not the major source of income.

The purpose of the notification requirement is to protect creditors from being defrauded by the secret sale of retail inventory in bulk.

The idea is to keep you from pocketing the money from a bulk sale of your inventory then disappearing and leaving your creditors holding the bag.

2. Business bank account(s) and direct debit arrangements:

After all payments have cleared your bank, you'll need to close your business accounts and cancel any business-related direct debit arrangements that exist. A final bank reconciliation should be performed.

3. Business insurance:

Cancel unnecessary business-related insurance policies. For example, workers' compensation insurance (if you had employees).

4. Business services:

Cancel any business services no longer needed (e.g., janitorial services, etc.).

5. Taxes:

Ensure that your taxes are up to date, including employment taxes and sales taxes (if any).

6. At year end:

  • Form W-2:
    • Ensure all required W-2 Forms are sent out timely (applies if you had employees).
    • W-2 forms are filed with the Social Security Administration.
    • Attach one Form W-3, the transmittal form, to all W-2s being filed with the Social Security Administration.
  • Form 1099-MISC:
    • Ensure Form 1099-MISC is sent out timely to independent contractors that you paid $600 or more during the year.
    • Must be received by contractors by January 31 of the following tax year.
    • 1099s are filed with the IRS. You keep a copy for your records.
    • Attach one Form 1096, the transmittal form, to all 1099s being filed with the IRS.
    • Form 1040:
      • File your own tax return.
        • Ensure that all relevant forms and schedules associated with the sale of your business are attached.
      • For example:
        • Form 8594, Asset Acquisition Statement
        • Form 6252, Installment Sale Income (if applicable).
        • Schedule D, Capital Gains and Losses (if applicable):
          • Section 1231 long-term capital gain (if any) is reported on Schedule D.

7. Employment taxes at year end:

This applies if you had employees.

A sole proprietor is not considered an employee of his own business except for retirement plan purposes. For example, if you set up a SIMPLE plan you are considered both and employer and employee for the purpose of making plan contributions for yourself.

  • Tax forms you need to file:
    • Form 940, Employer's Annual Federal Unemployment (FUTA) Tax.
    • Form 941, Employer's, Quarterly Federal Tax Return.
      • If you sold your business in the last quarter of the year, the due date of Form 941 will be January 31 of the following calendar year.
      • If you sold your business during the first three quarters of the year, Form 941 is due on the last day of the month following the last month of each quarter (e.g., the second quarter ends June 30. Form 941 is due July 31).

8. Recordkeeping:

Make sure you keep copies of every document related to the sale of your business in a safe place.

In an outright sale, keep such documents at least three years after the due date of your return, or the date you filed your return that includes the sale of your business, if later than the original due date.

If you sold your business on an installment basis, keep your records for a least three years after the year the final payment is received and you filed your tax return which includes the interest income and gain recognized on the final installment payments.

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Have an accounting or bookkeeping question? Email it to me.