December 21, 2015 Helpful Tips

It’s common to reevaluate the existing business structure, as well as each owners’ stake in the company, when a business experiences operational changes or growth. It’s also a good time to rethink your ownership percentages when a partial owner wants a greater piece of the business pie—either due to longer hours, more money brought to the table, or the acquisition of a premium client.

Any changes to ownership are not decisions you should make lightly, as they’re complex issues and have financial, tax, and legal implications. You’ll want to ensure any adjustments to your company’s business structure or its ownership percentages are completed after thorough due diligence. This will protect your own stake in the company, provide clear outlines for other owners and their interests, as well as ensure all abide by applicable state and federal laws.

Business Entity and Ownership Changes

Whether your business is an LLC, a sole proprietorship, an S-Corp, or a C-Corp, your business structure impacts your taxes, personal liability, and business credit. When you made the decision regarding the best business entity for your new company, the structure was based on your unique circumstances and goals.

It may have been a simple decision; for example, if you were just one person starting the company, a sole proprietorship may have been the obvious answer. If you decided to go forward with more than one owner, you know that it was more complex.

Just as the decision to set up a certain business structure is full of pro and cons, so is the possibility of changing business ownership percentages for an existing business.

The necessary steps and requirements to change ownership stake differ depending on the legal structure of your business. In short, there’s no cookie-cutter application for this complex business transaction.

A business or tax attorney can help to ensure proper due diligence and correct adherence to the necessary steps. While consulting an expert may be an additional cost, it’s a small cost compared to the potential of expensive litigation due to miscommunication or improper documentation.

Reasons to Change Ownership Percentages

Here are common reasons you might consider changing the ownership percentages of your business:

Going Full-Time as an Employee

You or some of your partners decided to spend more time as an employee for the company. Many start-ups begin with several part-time partners, who later sign on as full-time workers once profits roll in. As the business becomes more lucrative, it’s common for you to work more and wish to be compensated accordingly.

More Capital Output

You may begin your business as an equal financial partner, but then put in more money at a later date. In exchange for your added capital, you or others may wish to hold a greater stake in the company.

Working in Exchange for Shares

Perhaps you offered freelance work in exchange for an eventual stake in the company’s profits. This arrangement commonly applies to writers, editors, lawyers, and other professionals who can work on a freelance basis. Once the company is making a solid profit, you may wish to pursue added shares in exchange for your start-up work.

Attractive Business Credit Rates

If you’re applying for a loan, lenders will evaluate the credit of each of your shareholders (generally, any person with 20% or more ownership). Certain shareholders of your company may be more credit-worthy than others; therefore, you may seek to adjust ownership percentages accordingly to look more fiscally attractive to a bank.

While it may be appealing to take this approach in exchange for a low interest rate, experts advise exercising caution.  A better option might be to find a loan your company qualifies for at your present-day ownership structure. When your company is more financially solvent in the future, you then have the option to shop for better loan rates and refinance your business loan.

Considerations When Changing Ownership Percentages

This is a big decision with lasting consequences, and you want to make sure you’ve done the proper research before moving forward. Here is what to consider before you make a change.

Due Diligence

As we already mentioned, it’s best to consult the experts. Accountants, tax pros, business attorneys can all help advise.

Make it Formal

Especially in a small business, the temptation might be to simply have a verbal agreement to increase or decrease shares. This is a huge mistake.

Put it in writing so your rights—and those of your partners—are protected. This avoids hurt feelings or even worse, legal disputes, in the future if there’s a discrepancy in each owner’s perception of who gets what. Putting the plan in writing means all parties are clear from the outset.

Changing Ownership Percentages of S-Corps and C-Corps

Changing the ownership shares for an S-Corps and C-Corps can be more complex than the non-incorporated business structures. It requires certain steps to ensure that any change in ownership percentages is done correctly.

Due to the complex nature of this transaction, you’ll want expert help, but for educational purposes, here’s a simple overview of changing ownership for an S-Corp or a C-Corp:

Valuation

The first step before making any adjustments to ownerships percentages is to value the shares. An expert is necessary in this step, and a tax or corporate attorney is trained to evaluate the aggregate shares, as well as the tax implications of any adjustments.

Stock Purchase Agreements

Say your plan is to increase your stake in the company. A stock purchase agreement can allocate more shares to you. This allocation might make sense if you’d like to increase your ownership stake for any reason; maybe you’re working more than before, or maybe you’ve brought a new client to the company which you think impacts your value to the company in a positive way.

With a stock purchase agreement, you can keep others’ stake in the company the same, but increase yours. In this scenario, the business would issue a higher number of shares to you. The result of this issuance would boost the number of your shares (and your ownership percentage), while decreasing the other owners’ ownership percentages.

A second way to increase your ownership in the company is to buy back some of the other owners’ shares via a stock repurchase agreement. A stock repurchase agreement would reflect the increase to you and the adjustment to the other owners.

Updated Stock Ledger

Any change in ownership percentages should be recorded in the stock ledger. You (or your attorney) needs to record the transfers and then cancel the original stock certificate. A new certificate will be issued reflecting the amended number of shares.

Updated Articles of Incorporation

You also need to update the original Articles of Incorporation. You will then need to refile this amended document with the state for formal recognition of the ownership adjustments. This documentation is important, because not following the rules of incorporation means a court can “pierce the corporate veil” and hold you personally liable for your business debts and cancel your corporate status.

Conclusion

The nature of business is fluid, and as your business changes, the structure and percentage ownership of your business can, too. Since this issue is a technical one, it’s best to consult with your business experts to guide you before implementing changes to your business structure or business ownership percentages.

 

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