How you make an exit from your business is just as important as how you start it. Although often overlooked among entrepreneurs starting a business, the business exit strategy should be planned – or at the very least, thought about – right around the time your new business is launched.
It may sound crazy to think about leaving at some unknown time in the future right when starting out, sort of like thinking about how and when you’ll leave a job in the future – right after accepting an offer letter. However, planning your exit goes hand-in-hand with planning for the expected and for the unexpected.
Whether you’re planning to exit your business through a sale, or by closing your business entirely, business owners have a lot to consider; both in terms of business issues and legal ones. When planning your business exit strategy, you need to keep in mind the following legal considerations, regardless of whether you sell, close, or transfer the business.
1. Documents to keep up-to-date
While you need to keep certain documents current at all times, making sure that you keep these documents current will ease the transition process, whether you sell your business to someone else, or close the doors altogether.
Whether the contract is with a customer or a vendor, keeping current, up to date contracts is a must. Not only can you use these agreements to assist with your normal business planning process, but they are also invaluable when it comes to transitioning away from the business. If you decide to close the business, these agreements will let you know how much notice you need to give to either a customer or vendor and help guide you through the necessary notice requirements. If your plan is to sell the company, these agreements can help you with valuing the business, as well as setting forth what steps you need to take to either assign, transfer, or terminate the agreement.
- Intellectual property licenses (software licenses, trademarks, patents, copyrights)
When most business owners hear the phrase intellectual property, they immediately think of patents. However, as noted above, the phrase is more encompassing than that. Some of the more mundane, yet potentially costly intellectual property issues arise in the form of software licenses, trademarks, and copyrights. While some software licenses transfer with the machine, others may require a more formal process. Also, if you received permission to use someone else’s intellectual property, such as a trademark, you need to see what steps are necessary to transfer that license to the new ownership. Similarly, if you allowed someone else to use your intellectual property, the license that you granted will dictate how the royalties are collected.
- Miscellaneous Documents
Some other documents that you need to keep current at all times are your corporate minutes, business licenses, and banking documents. As a corporation, it is important that your corporate minutes are kept current, both from a shareholder perspective and a board of directors perspective. Not only will these documents make it much harder for someone to pierce the corporate veil if you are sued, but they will also illustrate to any potential purchaser that you take your company’s health and wellbeing seriously.
Along these same lines, it is important to stay on top of your banking documents. Keeping the list of those that can sign checks, access credit cards or other lines of credit, and whether or not personal guarantees exist is similarly important. There is no worse feeling after selling your interest in a business to find out that you are still personally responsible for a company’s debt that you are no longer part of.
2. Documents and items to consider if transferring business ownership
Transferring your business to a family member, whether it’s your child or your cousin, or to a third party, the sale of your business is not as easy as handing them a piece of paper that says they now own the business. While the impact of these documents will vary depending upon the nature of the sale, whether you are selling your stock/ownership interest in the company, or merely selling the company’s assets, the importance of keeping them current is a constant. There are several categories of documents all parties involved will need to handle.
- Ownership Documents
- Finance Documents
- Tax Documents
Ownership Documents. This category of documents involves documents that reflect not only your ownership of the company, but the company’s ownership of its assets. Maintaining current lists of stock ownership, membership interest ownership, buy-sell agreements, and corporate asset lists, are critical. These documents, especially a buy-sell agreement, will guide the structure of any transfer.
Maintaining an up-to-date registry of owners is vital because it is the owners that will decide if a deal is reasonable or not. While the Board may want to sell, it is the owners who have the final say. Also, because a sale of the business can be considered a fundamental business activity, you may need a super-majority of the owners on board with the deal for it to occur. As such, knowing who to contact, cannot be understated.
If you are merely selling your interest in the business, depending upon how large that interest is, can dictate if you need the approval of the other owners. Similarly, if a buy-sell agreement exists, you may need to offer your fellow owners the right to purchase your interest first, as well as jump through other hoops before you can sell.
Lastly, when you sell your business, it is important that a new Registered Agent filing occurs with the Texas Secretary of State. You no longer want to be, nor should you be, the point of contact for a company that you are no longer associated with.
Finance Documents. Like the banking documents discussed above, these documents are going to include corporate checking accounts, lines of credit, personal guarantees, as well as any UCC filings that grant security interests in the company’s assets. If you are selling your interest in the business, it is important that all personal guarantees are removed prior to closing. If you are selling the business’s assets, you will need to ensure that all loans are paid off, ahead of the asset transfer, and that all UCC filings are revised to reflect the new owner’s interest in the assets. Unless you sign a release from a personal guarantee, your personal assets can remain vulnerable to lenders, even after you transfer ownership.
Tax Documents. While it may seem rudimentary, ensuring that all documents relating to your company’s taxes are kept current. Not only are we talking about liability related to a Tax ID number, or Employee Identification Number (EIN) for federal taxes, in Texas, this also means your franchise tax documents and property tax documents. Furthermore, if you are selling your ownership interest or stock in the company, there could be capital gains taxes that you need to pay. If it is an asset sale, then the company needs to ensure that the appropriate tax treatment is applied for the sale of any short-term or long-term assets, along with any gains or losses on real estate.
If the plan is to transfer ownership to a family member, you may also need to consider any potential gift tax issues that may arise because of the value of the business.
3. Documents and items to consider when closing your business
Should you decide to close your business, as opposed to selling it, while some of the documents you need to review are similar to the sale process, others are not. For instance, keeping your contracts current, and knowing where they are, will help you in determining what steps you need to take to cancel them. With that said, there are two categories of documents to consider when closing your business.
- Government Documents
- Corporate Minutes
Government Documents. While some of these documents are similar to those listed above for when you sell your business, tax accounts for instance, it is also important to let the appropriate governmental authority know that you are closing your business and no longer need a business license. Many municipalities collect a fee for an annual business license. Others charge of registering your trade name locally. Notifying these agencies of the closing of the business will ensure that you are no longer paying unnecessary fees, and avoid any potential confusion should someone open a similarly named business in the future.
While we talked about tax returns, EINs, and other tax documents above when it comes to closing a business, there are final tax returns, and wrapping up documents that you need to file with the appropriate governmental agency. For instance, you need to file Notice of Dissolution documents with the Secretary of State, after you show proof that there the company’s franchise taxes are paid up. Similarly, you need to file final tax returns with the IRS and Texas Workforce Commission, in order to let them know that everything is closing and paid.
Regardless of whether you manage employees and contractors or if you were the sole employee of your business, you’ll still need to file your final employer tax returns – and make sure your business is in good standing before closing. Talk with your tax consultant or accountant to file the correct forms and report information before the deadline.
Corporate Minutes. When it comes to closing a business, there are some corporate formalities that you need to follow through on. Yes, you need to tell the Secretary of State that the company is no longer in business. In order to do this, and maintain the corporate liability shield, you need to jump through some formal hoops concerning the wrapping up of the company’s affairs and ensure that these steps are properly documented. These minutes will outline how the company’s assets and liabilities are disposed of, the payment of all final taxes owed to Federal, State, and Local taxing authorities, and the distribution of any excess funds/assets to the owners is occurring in light of their ownership interest.
Additionally, your business website should not remain part of the internet memorabilia once you decide to close your business. It’s important to prohibit the ability for anyone to purchase things from your website once you file to close your business. Noting what steps you took to close your website in your wrapping up documents can help alleviate any issues relating to future tax liabilities. While you need to pull your company’s website off of the internet, you may want to keep ownership of the domain name for a few years just to make sure that folks are not taken advantage of in the future.
Just because your business is no longer active does not mean you are exempt from risk thereafter. An option to those involved in these transactions is to purchase tail coverage insurance. Tail coverage is simply an insurance policy provision that allows those insured to make a claim for acts that occurred while a policy was valid – even if you file the claim after the policy has expired.
When you’re approaching the idea of exiting your business, will you close, sell or transfer ownership? These are the plans you should think about when launching a business to provide protection for you and your business in the future.
Additional issues that need to be addressed when preparing an exit will vary based on each business’s situation. Whether you’re selling, closing or transferring ownership, the process can have complex financial and legal obligations, which means it’s best to consult an experienced business lawyer before you enter into an agreement.
Have questions or concerns regarding your business exit strategy or drafting agreements? Contact my office for legal assistance today.