Many individuals and small businesses choose an S corporation as the legal entity for forming the company. This type of business structure combines many of the benefits of a sole proprietorship, corporation, and partnership without many of the disadvantages associated with those business structures. However, the sale of this type of company can be a bit tricky depending on the terms of the operating agreement and whether the company is a single-member S corporation or multi-member S-Corp.
1. Determine the value of ownership interest in the S corp.
The shareholders of an S corporation are its members. Since the business is a pass-through entity for tax purposes, members pay personal income taxes on their share of the business profits based on the number of shares or interest they own. If a member wishes to sell their interest, the first step is to determine the member's ownership interest by the number of shares they own.
It can be difficult to determine the price per share because the company is not a publicly traded company. If the operating agreement does not specify how to calculate the value of the member's interest, there are several ways the members may arrive at a value for the company shares.
Members may choose to base the price per share on a publicly traded corporation similar to the S corp. Members may also choose to calculate the anticipated net profit or value of the business and divide that total by the number of outstanding shares to arrive at a value for each share. Members must ensure that the method used to calculate the ownership interest does not violate the operating agreement for the S corporationor any current tax laws governing S corps.
2. Review the procedure for selling shares.
An S corp. must have an operating agreement that governs how the company operates. In many cases, the operating agreement contains a buyout agreement or buy-sell agreement that dictates the transfer of shares. In some cases, the operating agreement may require a member to sell shares to current members or family members of current members to ensure the company remains a family-owned and operated business.
Unless the operating agreement has restrictions on the sale of shares, the member should be able to transfer the shares to a party who is eligible to own an interest in an S corp. The IRS limits who may own an interest in the business. A member should also review any applicable state laws regarding the transfer of shares to another owner since state laws dictate the organization of such corporations.
3. Draft and execute a stock purchase agreement.
The member and the proposed owner must draft and execute a purchase agreement for the transfer of the shares to the new owner. This document should contain all relevant information related to the stock transfer such as the names of each party, the number of shares to transfer, and the price per share.
Step 4. Record the ownership transfer.
The business must record the transfer of ownership in its accounting system and stock registry. The member selling their shares receives a final K-1 from the company to reflect the member's interest in the profits and losses for the current tax period through the date of the stock transfer.
Depending on the type of S corporation and its members, selling an interest in the company or selling the entire company can be tricky. The company could lose its tax status for mistakes related to the transfer of a member's shares. A member could have a difficult time obtaining approval from other members for the sale of shares if the operating agreement is unclear or does not address the transfer of a member's ownership interest.
Before choosing to sell your shares, consider your options and the potential limitations, depending on what is stated in the operating agreement. Follow these steps, and work with the other members of the company to ensure a smooth transition of the S corp. ownership.
This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.
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