Do you want to transfer your sole proprietor business to someone else? If YES, here is a 6-step guide on how to transfer ownership of a sole proprietorship. We already know that sole proprietorship is the easiest type of business to form anywhere in the world.
There is no separate legal entity formed when you create a sole proprietorship for your business. It simply means that the owner of the business is the one in charge of all its debts and actions. Entrepreneurs prefer to create sole proprietorships because they are easy and cheap to establish. Investors like to acquire sole proprietorship businesses because they are only purchasing the assets of the business.
It entails less legal issues involved during the sales process. However, if you are a sole proprietorship who has some value in the business, you might be confused about how to sell or transfer the business because there is no separate legal entity. The specifics of the sales process will be discussed below.
6 Steps on How to Transfer Ownership of a Sole Proprietorship
Since a sole proprietorship represents the owner of the business, the business cannot actually be transferred to someone else. Every decision, legal obligations, and debts that you’ve undertaken throughout the lifetime of the business tends to remain with you and cannot be transferred to someone else. But if you are looking to transfer ownership by selling, here are steps and information to consider.
Table of Content
1. Know What You are Selling
In a sole proprietorship, you can sell and transfer the assets of the business to a new owner. These can be tangible assets, intangible assets, or both. But before the new owner can acquire these assets, they are expected to set up their own unique business structure first.
Note that this could be another sole proprietorship or another business entity type, like a Limited Liability Company. Immediately they have created their own business structure, the sales transaction for the assets can start.
Have it in mind that tangible assets of a sole proprietorship means all physical assets, such as inventory, supplies, land, buildings, and machinery. Intangible assets can mean all intellectual properties that are not physical such as trademarks, patents, copyrights, and brand names.
However, the owners always reserve the right to decide which of these assets they want to sell. But if you are looking to sell your business and you want to set the highest asking price possible, then its pertinent you include all the assets you have for the business so that it looks more attractive to potential buyers.
Once you know what assets you are selling, you need to determine a value for what the business is worth. You may want to hire an appraiser to help come up with a fair value. The value of your sole proprietorship is more or less determined by finding the value of your business’ assets and the total of its annual earnings.
A quick way to make this calculation is to take the total annual earnings of the business and multiply it by 5. This will just give you a rough estimate of what its worth but you don’t have to entirely base on this figure. It is advisable you first go through all your assets and determine what each one is worth. Asset valuations tend to be necessary because your buyer is only going to be buying your assets.
The annual earnings merely show the potential of your business model and how it makes money with the assets that you are using with it. Note that the idea is that once they acquire these assets and learn your business model, they will likely be able to make the same annual earnings once they start using these assets with their own business.
To effectively figure out the value of tangible assets, you just have to look at their market values. Real estate, for instance, tend to be quite easy to value because your local county already sets a market value for your property. Other physical items like inventory can be valued based on their current wholesale price.
But for the intangible assets, they can be valued based on how much money they make your business. If you own a brand that has recognition from a loyal customer base, the amount of annual earnings this brand generates will determine its worth.
The value of your brand and its customer base is referred to as “goodwill”. Do not forget that your business customer list is the most valuable intangible asset of your business, whether it is constrained to a brand or not.
Your customer list is a priceless advantage to your buyer because they can just take that list and continue selling the same products and services that you were selling. It is more like a guarantee to your buyer that they’ll be able to take your assets and make money immediately with them because they already have the list of customers who would patronise them.
3. Sales Agreement
As a sole proprietorship, the Sales Agreement is very important to use for the transaction. This agreement must highlight every of your business assets that are being transferred with the sale of the business. It is also meant to list any other stipulations that concern the operation of the business after the assets are transferred. For instance, a non – compete agreement is commonly used in conjunction with a Sales Agreement.
Note that this non – compete agreement offers the buyer protection by assuring them that you aren’t going to start a similar business within the same location and using the same customers. This agreement could also give you the right to keep your existing clients because they have already developed a working relationship with you. All these specifics need to be addressed at this point of the sales process.
Coupled with the intangible assets, you will also have to list all the tangible assets in the Sales Agreement. It simply means every atom of inventory, machinery, real estate, and other property that you choose to transfer. In some scenarios, sellers want to include a provision in the agreement where they offer training to the buyer.
Hence, they will learn how to run their new business just like you ran your sole proprietorship. This is always optional, but it offers a nice incentive to attract buyers to acquire your business assets.
Buyers normally want to see in writing that they will not be tasked with any existing debts that were accumulated by the owner. This tends to be very important when buyers end up requesting credit for the business. In order to avoid confusion, a Sales Agreement has to be provided to the lender which outlines that they are not the ones who owe this debt.
4. The Handling of Debts
As the seller, you will be expected to pay back all the money you owe. Note that this could be money owed to banks, suppliers, or other creditors. It is important to state that the sale of your business is not going to change this fact. If you do not pay back your debts, these lenders could end up suing you personally in civil court which will normally affect your personal credit rating.
Have it in mind that this is the major downside to sole proprietorships because the creditors cannot go after a separate business entity. However, the good news is that the debts and liabilities have no effect on the buyer.
So, even if you owe a lot of money to anyone, you can still sell your business and not bother about clearing the debts first. A lot of owners will use the proceeds from the sale of their business to pay back the creditors, though. You can choose to do this if you want to but it is not required when selling a sole proprietorship.
5. Closing the Sale
Immediately the Sales Agreement has been signed by both parties, the proper closing of the sale can start. This involves handing over all the tangible assets to the buyer and transferring all the intangible assets to them as well. For instance, if vehicles or real estate assets were included in the sale, you are expected to sign over the deed or title paperwork to the buyer so they can take over ownership of them.
For other things like tax identification numbers and the DBA business name, these are not transferable with the sale of a sole proprietorship. You must basically dissolve each of these things. Note that for the tax identification number, you have to contact the Internal Revenue Service and let them know you are closing your company so they can dissolve the number.
After that, you also have to contact your Secretary of State’s office and file dissolution paperwork to dissolve the business and its DBA company name. Do not forget that any brand names you sold for the business need to be transferred through the U.S. Patent and Trademark Office.
6. Tax Implications
Have it in mind that the sale of your sole proprietorship tends to come with certain tax implications. Since you are only selling assets from your business, you are expected to list them as capital gains on the Schedule D form of your personal tax return. The capital gains tax rate can be as high as 23.8 percent depending on how much net profit you made from the sale of the assets. Howbeit, most of the money you receive from the sale will likely get taxed.
When you go to list how much money you paid for the assets on your tax return, the Internal Revenue Service tend not factor in the cost associated with intangible assets. They only consider the money paid for tangible assets. For instance, if your business consists of $1,000 in inventory, a $500 laptop, and a customer list worth $10,000.
If you sold your business for $9,000, then the Internal Revenue Service will tax $7,500 of that amount because it only subtracts the cost of the laptop and inventory from the sale amount. It entails that you will have to pay more money in taxes.
Transfer of business ownership, as noted above, require valuations and written agreements. It is pertinent to keep in mind that the details of the transaction should always be clear between the person giving up their interest and the person obtaining it. Besides that, a licensed attorney can help you with business ownership interest transfers.