Taking over a Business

[FamilyGuy87]

Before I start I just wanted to say that we will be talking to a CPA/Lawyer about this but I wanted to get the thoughts and the opinion of Bogleheads.

I have a friend who owns a S Corp LLC. My friend will be unable to own/operate this business going forward due to a conflict of interest (not relevant to this question). She would like me to take over the business ownership and operations. Based upon the conversations we have had here are the details:

• The S Corp has an established contract with local businesses.

• This S Corp sub contracts consultants and offers their services to the local businesses.

• The primary revenue source currently is by taking share of the revenue the sub contractors earn. For example if they charge the business $50 and hour the S Corp takes $10/hour as a fee.

• Primary work will be administration and payroll.

• She wants to pass on the ownership of the company without any upfront payment. Instead she wants a share of the $10/hour fee that the S Corp charges. (for example $3/hour)

So here are my questions:

1. What are some of the common mistakes or issues I need to be aware of and look into prior to doing this. Currently, since there is no upfront capital cost to me, I do not see a major personal risk.
2. How would the proposed ownership transferring/ongoing fee structure work? She owns the S Corp on a personal level and she will essentially be transferring the ownership to me for a $1?. Then the S Corp will have an ongoing expense? What would I classify this expense? (I know the CPA will be able to help with this aspect, I just need some thoughts and opinions prior to meeting with the CPA)
3. Lastly, I have my own LLC (sole proprietorship). Is there any advantage of transferring the ownership of this company under the LLC?

Thank you very much for your thoughts!

FamilyGuy

[Liberty1100]

1) I would make sure you think about what will happen to new and old business. I would make sure you outline if the subcontractor starts working for another business contact that you made, how does the fee get broken up. She probably doesn't deserve 100% of the $3, but maybe say $1 of the $10.

Remember, you are taking all of the risks and doing all of the work. Maybe you can cap the royalty at a number. Say after paying out 1500 hours worked in royalties to her, you decrease the royalty from $3 to $1/hr. (Think bonus, turnover, and possibly salary increase likelihood of your subcontractor.)

I would also suggest a time limit. Such as after 3 years, the royalty decreases to $1/hr. After two more years, it decreases to $0/hr.

[HomeStretch]

As far as acquiring the company goes, the CPA and attorney will be in the best position to advise you on legal and tax implications of buying the company versus buying the assets. The former means you assume all liabilities. Buying the assets is usually an easier due diligence and less risk of undisclosed liabilities popping up.

[FamilyGuy87]

Buying just the assets is not an option at the moment. But that is a good point.

[niceguy7376]

If there are employees in the business on whose backs, the owner makes the money, how is the $10 margin calculated?
In the given example of OP, they get $10 as fee and then run how much of the reaming as payroll to employee?
If they get $50 and run a $40 payroll to employee, the employer margin is a lot less than $10 considering Employer share of SS+medicare taxes, Unemployment taxes, Insurances and such.

[HomeStretch]

At a minimum, the sales contract should contain representations including that there are no outstanding tax liabilities, lawsuits, judgments, etc. to give you recourse or right of offset against the current owner.

Agree with prior poster that the revenue share/royalty should not continue indefinitely. It’s just a form of paying the purchase price. So be sure to agree on the value of the business and next on how to pay it.

[FamilyGuy87]

At a minimum, the sales contract should contain representations including that there are no outstanding tax liabilities, lawsuits, judgments, etc. to give you recourse or right of offset against the current owner.

Agree with prior poster that the revenue share/royalty should not continue indefinitely. It’s just a form of paying the purchase price. So be sure to agree on the value of the business and next on how to pay it.

Very good points.

Can you think of any risk to me personally ( financial and non financial) since there is no upfront cash payment.

[MarkerFM]

I agree with setting some time limit on the royalty. Also, perhaps a smaller/0 royalty on any new business you generate.

Clarify with the CPA whether the royalties are an expense or purchase price (and therefore become your basis). Expense is better because it's an immediate deduction and at least for now capital gains rates are lower. The answer might be dependent on how you structure the agreement, so worth considering.

[smitcat]

At a minimum, the sales contract should contain representations including that there are no outstanding tax liabilities, lawsuits, judgments, etc. to give you recourse or right of offset against the current owner.

Agree with prior poster that the revenue share/royalty should not continue indefinitely. It’s just a form of paying the purchase price. So be sure to agree on the value of the business and next on how to pay it.

Very good points.

Can you think of any risk to me personally ( financial and non financial) since there is no upfront cash payment.

"Can you think of any risk to me personally ( financial and non financial) since there is no upfront cash payment."
- taxes due on a stock sale business
- liability insurance taken at a rate that will protect your interests
- a sale indicating that a lump sum will be due if you decide to do X .. Y or Z in the future
- liability from sub contractors that pass along with the sale
- liability from services previously rendered that pass along with sale (warrantee or other)
- legal issue if contractors deemed 'employees' definition in future
- any leases, property, contracts, utilities etc toed to business sale
These and many other questions are best left for your specifically selected business purchase attorney - asking questions with very little information available on a website will be lacking in many ways.

[3CT_Paddler]

Before I start I just wanted to say that we will be talking to a CPA/Lawyer about this but I wanted to get the thoughts and the opinion of Bogleheads.

I have a friend who owns a S Corp LLC. My friend will be unable to own/operate this business going forward due to a conflict of interest (not relevant to this question). She would like me to take over the business ownership and operations. Based upon the conversations we have had here are the details:

• The S Corp has an established contract with local businesses.

• This S Corp sub contracts consultants and offers their services to the local businesses.

• The primary revenue source currently is by taking share of the revenue the sub contractors earn. For example if they charge the business $50 and hour the S Corp takes $10/hour as a fee.

• Primary work will be administration and payroll.

• She wants to pass on the ownership of the company without any upfront payment. Instead she wants a share of the $10/hour fee that the S Corp charges. (for example $3/hour)

So here are my questions:

1. What are some of the common mistakes or issues I need to be aware of and look into prior to doing this. Currently, since there is no upfront capital cost to me, I do not see a major personal risk.
2. How would the proposed ownership transferring/ongoing fee structure work? She owns the S Corp on a personal level and she will essentially be transferring the ownership to me for a $1?. Then the S Corp will have an ongoing expense? What would I classify this expense? (I know the CPA will be able to help with this aspect, I just need some thoughts and opinions prior to meeting with the CPA)
3. Lastly, I have my own LLC (sole proprietorship). Is there any advantage of transferring the ownership of this company under the LLC?

Thank you very much for your thoughts!

FamilyGuy

If she passes ownership with a $1 purchase price then what do those ongoing payments qualify as? Seems like a CPA question...

[FamilyGuy87]

Thanks for the replies!

[petulant]

If the current owner has a conflict of interest from operating the business now, how is the current owner getting out of the conflict of interest if the owner has an ongoing expectation of payments from the business? That seems like a pretty big conceptual problem.

Honestly that recurring fee is a big deal. I would have a CPA or some other analyst estimate the actual value of the business and attempt to pay it.

You never know what kind of problem you would have from a perpetual fee being owed to somebody else--what if you automate something, drastically cut fees to stimulate new business, but then have that $3 hanging around your neck? What if she demands an accounting and doesn't like how you did something? What if $3 per hour is all of the fair business profit, and $7 per hour is just your labor time on generating contracts then doing administrative work--it would never be in your interest to grow.