Buying into an existing business involves a share purchase for a corporation, or a membership purchase for a limited liability company. Let’s talk about what that means for a corporate share purchase (LLCs are essentially the same, but different terminology).
What “Buying Into” a Business Means
A share purchase from an existing business is just that – you purchase shares. Shares are ownership. Same thing for a limited liability company. You buy the shares, you own that share of the business.
What we’re talking about here is where there is an existing, operating business that has other shareholders, and you want to own part of it. Things you need to look at before buying in can include:
- How are the shares being paid for
- Are they current in all their tax payment obligations
- Is the businesses insurance and other debts paid up
- Is the business facing or in litigation for anything
- Will you, as a new owner, be required to work at the business
- Are there any restrictions on transferring the shares (selling them, transfer on death)
The things to look at when making a share purchase into an existing business are just about the same things you’d look at when buying. However, when outright buying an existing business, we generally like to set up a new entity and just purchase the selling entity’s assets. That way we wash out the liabilities, which stay with the selling business.
The Mechanism of the Share Purchase Agreement
The actual mechanism for the share purchase agreement, a simple one, is about a two page document. Basically it says you are buying a certain amount of shares, for a set price. The rest is legal mumbo jumbo.
It can quickly get complicated, though, when the factors I listed above are not straightforward.
Complications in the Share Purchase Deal
For example, if the shares are to be awarded for work performed, then the work performed has to be set out, as well as a vesting schedule. For example, you get 100 shares after your first year working at the business. Likewise, if there is a payment schedule rather than a lump-sum payment, that has to be set out as well as penalties or forfeitures for non-payment.
Restrictions on the transfer of shares, or giving existing shareholders the right to buy the shares before you can sell them add complexity. Those have to be set out in the agreement. Also, you need to find out before making the purchase whether the seller is violating any existing restriction. A review of the bylaws and any shareholder agreements is necessary for this.
If there are pre-existing liabilities of the business, you have to deal with those. They may be reflected in a reduced share price. You can also set out that your profit share will not be reduced if the business has to make a payment on a liability that pre-dated your ownership. Complexity.
Buying Shares From a Shareholder v. Buying Shares From the Company
The “cost basis” of your shares is set by the purchase price. That number is used to determine your profit or loss when you sell the shares later on. You may not have a choice whether to purchase from a shareholder or from the business, for example, if an owner is cashing out. But if the business is bringing you in as a new owner, you will be buying the shares from the company itself.
The cost basis for those shares is a tax question. Buying shares is not a taxable event, but selling them is. Always talk with your tax advisor when making the purchase to hash out these issues.
Conclusion
Even though the document for a share purchase may look simple, there’s a lot of lawyering that may go into drafting it. If you are contemplating a share purchase, or if your business is selling ownership, be sure to call me early on in the process so we can go over these and other issues with the transaction.
Call me at (312) 671-6453 or email at palermo@palermolaw.com
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