Transferring ownership of Your LLC

Your business entity type, state laws, operating agreement, and what buyers look for all play a role in how you prepare to sell your business.

Check Rules for Your Business Entity Type

Companies structured as publicly held corporations allow shareholders to freely sell their shares on the open market, but most other business entities restrict whether and how owners may sell their interest in the business.

• Closely held corporations, which are often family businesses, typically restrict an owner's ability to transfer or sell shares.
• Sole proprietorships cannot transfer outstanding debts or liabilities in a sale. These business owners can only sell their company assets.
• General partnerships often have agreements that dictate whether and how a partner's interest may be sold, because the remaining partners want a say in who joins the partnership. These agreements might require someone departing the partnership to sell back their interest to the remaining partners, and they often set a formula for determining the value of the interest.
• The articles of organization or operating agreements for limited liability companies (LLCs) that have more than one member also typically limit a member's ability to sell their shares on the open market. Some states also dictate the sale terms for these business entity types.

Selling or Transferring Partial Ownership in an LLC

Most LLCs with two or more members have written agreements (called "buy-sell agreements") that cover selling or transferring a partial ownership interest. The agreement can be within the rules of organization or the operating agreement, created when the LLC was formed; or the LLC can adopt one later.

The buy-sell agreement might include requirements for becoming a member of the LLC, which would mean you couldn't sell your ownership share to just anyone who was interested in buying it. The agreement might allow only the other LLC members to buy back a member's interest, or it might require that only the business itself can buy back a member's interest.

Buy-sell agreements also usually dictate the process for distributing the remaining interest of a member who departs the group, how the interest is valued, and the approval process required.

An LLC that doesn't have a buy-sell agreement might be subject to state laws for selling or transferring shares. Some states require LLCs to be dissolved when a member leaves.

Single-member LLCs wouldn't typically place restrictions on selling or transferring shares. Nevertheless, it's a good idea to check the operating agreement in case it contains anything that might interfere and modify the agreement if needed. You should also consult the appropriate state agency for rules on reporting the sale.

If your business entity type, operating agreement, and state rules allow, the steps below will provide a roadmap to selling your business.

1. Determine What You Are Selling

Before you can set a price for your business, you'll have to clearly define what it is you're selling—equity or assets.

In an asset sale, the buyer acquires some or all of the assets of the business, such as inventory, accounts receivable, and equipment. Except in the case of sole proprietorships, buyers can also purchase the liabilities and debts of the business. Buyer and seller negotiate the assets and liabilities they want to include in the sale.

In an equity sale, also called a stock sale, the buyer acquires all of the business as it exists, including all of the assets and any liabilities such as pending lawsuits; and any debts such as outstanding loans or accounts receivable.

2. Set a Price

Determining a company's value depends on many variables, which can be hard to measure. Owners often engage appraisers or CPAs (and some operating agreements require that they do so) to help set a sale price. The appraiser will consider:

• historical sales and earnings
• the company's market share
• trends in the industry
• the company's competitive advantages, and
• future growth potential and limitations.

When all is said and done, your business is worth what a buyer is willing to pay for it. But if you can enumerate and quantify the reasons behind the asking price, you'll be in a strong position to negotiate.

Once you take the above factors and others into account, you can use a number of formulas to set a sale price. The most commonly used formulas include:

Revenue- profit- or earnings-based valuations. This formula multiplies the company's revenue (gross income), net profit (profit after business expenses), or earnings before interest, taxes, depreciation, and amortization – EBITDA – by a number that's accepted as the standard in that industry. The so-called multiplier might be 2, 4, 10, or another number, depending on the industry and the multipliers that recent, similar business sales used. Each industry has its own standard for determining the amount of the multiplier and applies different multipliers depending on whether the sellers use revenues, net income, or EBITDA for the calculation.

For example, if your gross annual sales are $500,000, and the industry in which you operate uses a multiplier of 4, you'd multiply $500,000 by 4 to arrive at a valuation of $2 million.

You might find you have to adjust a multiplier to account for differences between your company and others that have recently sold. Considerations such as whether a company is public or private, the competitive environment, and the intellectual property a business holds, can call for adjusting the industry standard multiplier—either up or down.

Asset-based valuations. This method, also called book-value, calculates the value of the business based on the cash value of assets minus the company's liabilities. Assets might be real estate, equipment, or inventory that the business owns. Liabilities might include outstanding mortgages or other commercial loans.

Let's say the A2Z Printing Company has $35,000 worth of printing and binding equipment, computers, and software; an inventory of paper products worth $5,000; and another $50,000 in delivery trucks and other equipment. The business owns all the equipment free and clear of any loans except for a remaining $5,000 on a loan to purchase one delivery truck. A2Z's $90,000 in assets less the $5,000 vehicle loan would amount to a value of $85,000 for the business.

Future revenue-based projections. Also called a discounted cash flow (DCA) model, this method projects a company's future cash flow for a period of time like five or ten years, and applies a discount to that total based on a number of factors such as inflation rates and the cost of capital, to arrive at a present-day value.

Because using future revenues to arrive at a company valuation involves many different assumptions, this method is typically used only by experienced appraisers.

Market comparables. This method uses recent sales of similar businesses to arrive at a valuation. It can be difficult to use this method when you are selling a small business, because the prices at which other businesses have sold are not often publicly available.

3. Put Your Books in Order

It's a good idea to start planning your exit strategy in advance of your anticipated sale date. Buyers want to feel confident that they're acquiring a stable, professionally managed company with predictable returns and few risks. With a little planning, you'll be able to button up and document practices and procedures, and gather and organize important items and information. Some of the items to consider include:

Improve your balance sheet. Review your balance sheet to see whether you can cut expenses; or perhaps you can expand your business to put your best financial foot forward. Pay special attention to discretionary expenses that a new owner might not feel are necessary (like travel), and eliminate them to improve your profit picture.

Establish consistent financial reporting practices. Document your accounting practices and prepare financial statements on a monthly or quarterly basis. Consider engaging an independent audit company to validate your reporting.

Itemize your assets. Create a list of all tangible and intangible assets, including equipment, inventory, customer contracts, and intellectual property such as copyrighted logos and marketing slogans. By assigning values to each asset you list, you'll be better able to justify the sale price.

Gather documents. Gather and organize business documents, including business plans, operating agreements, real estate and vehicle leases, permits and licenses, vendor and customer contracts, loan agreements, insurance policies, business formation documents, employment contracts, and tax documents.

4. Find a Buyer

Many small businesses hire business brokers to find potential buyers. These professionals can also assist with the mechanics of the sale, from setting a price to executing purchase agreements. M&A advisors (who specialize in mergers and acquisitions) and investment bankers also assist in locating potential buyers and executing sales. These professionals typically work with mid-sized and large companies.

Don't assume that a business broker, M&A advisor, or investment banker will have the expertise to advise you on tax liabilities resulting from a sale, or legal issues that might arise. Depending on your business and your situation, you might also want to engage a CPA or attorney.

If you are going it alone, start by identifying the types of businesses that might have interest in buying your company, such as suppliers, competitors, or businesses that use your products or services. Then do a deeper dive to identify the companies and decision makers to contact.

Making your company more visible in the marketplace can also draw out potential buyers. Consider joining trade associations and exhibiting or speaking at their shows. You might also contribute guest columns to industry publications or hire a media relations agency or expert to identify opportunities to get your company's name in front of potential buyers.

5. Negotiate with Interested Buyers

To negotiate effectively, it's important to understand the point of view of the buyers who come to the table. By carefully listening to the feedback you receive, you can adjust your pricing and terms to market realities.

Before sharing a lot of proprietary information about your company, it's important to conduct your own due diligence to verify that the prospective buyers are serious about making an acquisition and have the wherewithal to close on the sale.

If you're lucky enough to attract multiple prospective buyers, you'll want to keep all of them actively engaged throughout the process so that you can achieve the best possible price for your business.

6. Execute a Letter of Intent

A letter of intent is a roadmap that outlines basic terms for the sale of a business. It's used when a seller selects one buyer, and both are relatively confident that they can reach a deal.

Drafting a letter of intent prior to a sales agreement can help save time by ensuring that buyer and seller are on the same page before negotiations get too far along. You'll need to make certain, however, that your letter of intent clearly states it is non-binding, so that you don't get locked into terms you're unwilling to meet.

No matter how much you've discussed the details of your operation with a prospective buyer, the buyer will want to conduct its own due diligence before completing a purchase agreement. Once buyer and seller are each comfortable with the terms in a letter of intent, you'll need to give the buyer access to all of the information about your business, including financial statements and tax returns, accounts payable and receivable reports, supplier and distributor contracts, client lists and contacts, leases, and employment agreements.

7. Execute a Purchase Agreement

A purchase agreement is a legally binding document that details exactly what the buyer is purchasing. It should include all the details of the sale, including property, contracts, liabilities, and debts, the sale price, and terms. Both parties sign the agreement. If your business has taken out a loan that you intend will be assumed by the new owner, you will probably need to get the lender's agreement to the sale. Likewise, check with your insurer about any impact on your policies.

You can use an online template to draft a purchase agreement yourself, or hire an attorney to create one for you. Even if you draft the agreement yourself, it's advisable to have it reviewed by an attorney before the final agreement, to make sure that the wording protects your interests if problems arise down the road. But be forewarned: In order to make sure the agreement suits your interests, the lawyer will need to learn a lot about your business and its history. The consultation might not be inexpensive, but it will be worth it if you can avoid costly problems caused by a faulty or unclear sales contract.

8. Close the Sale

It's customary to close a business sale at a closing meeting. The buyer turns over any remaining payments owed, and the seller turns over keys, alarm codes and passwords, customer lists, and other documents.

Once the sale closes, sellers will also have to inform the IRS and relevant state agencies of the ownership change. Unless they have already done so, sellers will also inform suppliers and distributors, banks and lenders, and others with whom they have a business relationship.