Buying A Company ... Ask TaxMama ... July 16, 2004

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Published by Eva Rosenberg, MBA, EA
Volume 6, Issue 267 July 16, 2004


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Buying A Company

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Dear Eva:

As usual your article was wonderful and enlighting.

But now I have a question.

I am a sole Proprietor and I took out a home equity line of credit to start my buiness.

My bookkeepper wants to buy into the company and become a partner, she wants to work off what her share would be.

How do I determine what the basis of the company is?

She wants to buy in at 20% but 20% of what?

Thanks

Rochelle

Hi Rochelle,

Thanks for the kind words.

How much your business is worth?

That's not an easy question to answer. There really are so many factors that go into it - the first of which is what IS the business?

Basically, if you have a service business, one where you don't have a product or a shop or inventory - tangible assets, the real value of the business is the client base and your good name.

Typically, for a service business, the selling price tends to be a multiple of the annual sales. (1 times, or 1.5 times, or two or three times, depending on the uniqueness of the business and how loyal the clients will still be without you.)

With you staying, of course, there's no problem about clients leaving. So that makes it worth more.

You need to factor in the value of any equipment that is being sold (i.e. she's buying 20% of the business, do YOU continue to own your computer, etc., or does the business?

Here are some articles to help you define the value, if you don't want to pay a business appraiser for a formal valuation:

Will You Get Top Dollar When It's Time to Sell

Valuation Guidelines

How does the business valuation process work?

What's It Worth?

Once you determine the value, you're going to want to write up a contract, and note. Your bookkeeping will formally owe you the money. Describe payment terms - monthly amount, interest rate and due date.

Describe what happens if she doesn't pay it all.

I strongly recommend that you two arrange for actual, tangible payments. None of this working it off stuff.

You pay her for her time. And she can use that money to pay her debt to you. Don't just try to make it work by agreeing that she works so many hours each month to earn her position. You'll both end up unhappy. Trust me on this.

Make sure that you get paid for YOUR time. Then, once you've each been paid, and the bills are paid, you can split the profits 20% 80% .... or decide to leave the money in to grow the business.

But work out the details and decide if you're going to be a partnership, LLC, or what.

Fred Daily's book, Tax Savvy for Small Business will help you with that decision.

(better yet, talk to your tax pro and your tax attorney to work out your best options in your state.)

This should give you both a starting point

Best wishes,

Eva Rosenberg
Your TaxMama

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