06 Mar Early Stage: Step 18 – Asset clean-up issues
Editor’s note: This is the 18th and final installment in a series of articles on developing start-up companies in the technology or biotechnology sectors.
Madison, Wis. – The last few columns discussed selling your business. Specifically, they focused on asset sales. An asset sale is the most likely alternative for a small company because the buyer wants to avoid unknown liabilities. If an asset sale occurs, the seller is left with the closure of an entity.
Starting and ending a business is much like a marriage. It is much easier to get married (i.e. to start a business) than it is to get divorced (i.e., close a business). This will become evident as we discuss what you need to do here to close the entity.
You must consider what authorizations are necessary to close the entity. First, let’s discuss the possibilities.
Step 5 discussed entity types. Ordinarily now in Wisconsin, small businesses are LLCs. An LLC can either be member or manager-managed. That is critical to the determination of who is authorized to approve the sale. If the entity is member-managed, then the members must authorize the sale. If the entity is manager-managed, then the manager(s) must first approve the sale and have it ratified by the members. This is generally what happens. If there is an operating agreement for the entity, one must review it to comply with its provisions.
If the entity is a corporation, either S or C, the board of directors must approve the sale and the shareholders must ratify it. Again, the corporate articles of incorporation, bylaws, and other documents must be reviewed to make sure that all approvals are obtained.
Now that the sale has been properly authorized, we review the tax issues. Step 6 discussed the differences in income taxes between entities. If you are either an S corporation or an LLC, this discussion is slightly different than if you are a C corporation. If you are a C corporation, then the corporation must pay a tax on the gain from the asset sale. Some of the tax will be ordinary income taxes and some will be capital gain. After the tax estimate is determined, it is paid when normally due.
We will assume that you will sell the business for cash and not on an installment basis (meaning not taking “paper back.”) In a later discussion, we will discuss selling on an installment basis. If it was sold for cash, it is a simpler situation. After you have paid the taxes and all other liabilities, you can distribute the remainder of the assets to the owners/shareholders/ members/partners depending on the entity type.
But first you should estimate what outstanding liabilities must be paid. This number can be difficult to determine. There may be taxes that are still due and unknown claims that have yet to be paid, whether from known or unknown creditors.
What does this mean? When you close a business, it could very well be that there are uncompleted transactions. Uncompleted transactions should be dealt with in the sales agreement between the buyer and seller. Often times, the buyer takes over unfinished transactions. In that case, the seller does not have to worry about completing them. However in other cases, the seller has to finish uncompleted transactions.
In addition, there may be products and other services which have been rendered over the years for which there are outstanding contingent liabilities. The corporate and the LLC statutes present a solution to this problem. How to tie up the “loose ends” on these transactions is important.
Understanding the statute of limitations also is important because claims must be brought within these time frames. One must determine the type of claim and the applicable statute of limitations for each one. The statute of limitations for a tort claim is three years. Contract claims can be made up to six years. Tax liability claims depends upon whether it is federal or state.
Nonetheless, there is a procedure in the corporate and LLC statutes to deal with this issue. For “known creditors” such as bank debts, you can notify the known creditor per the Wisconsin statutes limiting the claims period to 120 days. If the known creditor does not file a claim within that time period contesting the claims amount, the creditor is limited to the amount stated in the notice.
Other claims are “unknown claims.” These unknown claims may include product liability, malpractice or other tort claims. To limit these claims to as little as a two year statute of limitations (these are usually tort claims or contract disputes), you must file a notice in a local paper of general circulation that the business is closing as of a certain date and that claims must be filed within a two year period to be valid. If a claim is not filed within this two year period, it is terminated.
In my private practice I have found that clients do not want to file this notice because they do not like, in effect, notifying third parties that there may be claims against them. This is narrow thinking. Whenever you can limit the statute of limitations, you should.
If you use this procedure, you can then estimate what the claims may be and set aside that amount of money. After this step, you can distribute the net assets to the owners. (This is in partial liquidation of their ownership. This is true whether the entity is a C or S Corporation or an LLC).
If you sold the business for part cash and for a note on an installment basis, you can distribute the note and the cash. Again, set aside funds to cover the estimated future claims.
Too complicated to go it alone
Once this has been done, you then have to decide whether the funds you are keeping to pay unpaid bills can be distributed to the owners through a trust to be held by them or whether you keep the entity, in effect, open until such time as the claims have been satisfied.
As illustrated above, selling a business can be complicated. You should seek professional assistance as necessary.
Previous Early-Stage articles by Joe Boucher
• Joe Boucher: Early Stage, Step 17: Sale of the business – assets vs. stock
• Joe Boucher: Early Stage, Step 16: Sale of business a taxing exercise
• Joe Boucher: Early Stage: Step 15 – A license to sell
• Joe Boucher: Early Stage, Step 14: Strategic partnerships require legal protections
• Joe Boucher: Early Stage, Step 13: The advantages of leasing real estate
• Joe Boucher: Early Stage: Step 12 – Alternative forms of business finance
• Joe Boucher: Early Stage: Step 11 – Other forms of finance
• Joe Boucher: Early Stage 10: The nuances of federal laws
• Joe Boucher: Early Stage, Step 9: Raising capital in the securities landscape
• Early Stage, Step 8: Misclassifying workers brings risk
• Joe Boucher and Bonnie Wendorff: Early Stage 7, Part I: Just what is an employee?
• Joe Boucher: Early Stage: Step 6 – Taxes, taxes, taxes!
• Joe Boucher: Early Stage: Step 5 – Forming the entity
• Joe Boucher: Early Stage, Step 4: Cautionary trademark tales
• Joe Boucher: Early Stage, Step 3: Naming the entity
• Joe Boucher: Early Stage Step 2: Choosing a domain name
• Joe Boucher: Starting a tech business? Step 1 is minding the intellectual property
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