If you have an ownership stake in a small business, it’s not uncommon to experience growing pains. As your company expands and your goals shift, you might even decide that you want to take a bigger stake. On the flipside, you might want to sell your shares or bring in a new partner. Let’s talk about your business’s ownership percentages.
Because change can be overwhelming, especially when running a growing company and managing daily tasks, many small business owners put changing ownership shares on the backburner or opt to change ownership informally. But experts say that taking the proper steps is important, in order to ensure that your ownership stake is protected.
For example: You have one partner, each of you owns 50%, and you want to take a 75% stake. If you and your partner agree to shift the percentages, it’s important that your new majority share is official for both financial reasons and for promoting a positive working relationship with your partner.
4 Steps for an S Corporation
Depending on the structure of your business, changing ownership might require different steps. Let’s assume your business is an S corporation—a popular structure for small companies with fewer than 100 shareholders. Unlike some company formations, where both the business and its owners are required to pay taxes, S corporations have a special tax status with the Internal Revenue Service: income is passed along to individual owners, who pay taxes on their shares.
As an S corporation, here’s an example of the steps you’ll need to take if you’re considering changing your ownership percentages:
1. Know the worth of your shares
This may seem pretty basic, but it’s a critical first step. In many cases, business owners don’t know what their company and its shares are worth. It might be a good idea to consult a tax attorney who can help you determine your company’s value, and understand how a new share structure will affect your taxes.
2. Decide how to change your ownership percentages
There are a couple common ways to do this. Take a look:
- If you want to increase your stake in the business, the company can allocate more shares to you. In this scenario, you would draw up a stock purchase agreement.
This would be a good situation if, say, your company has three partners, including you, and each has 50 shares and 33% of the company. You decide to work full-time at the company and would like a higher ownership stake for your efforts. The other two partners agree, but still want to own their original shares. So, instead of buying back shares from your partners, your company issues more shares to you. Your percentage stake would then increase and the other percentages would decrease. You would have more shares and each of your partners would retain their original 50 shares.
- You could buy some of your partner’s shares, increasing your ownership and giving you a bigger piece of the pie. In this scenario, you would draw up a stock repurchase agreement to reflect the reallocation of shares between the owners.
“In each situation you need a purchase or repurchase agreement or other transfer document to give effect to the new ownership percentages,” says Danielle Lauzon, a partner at Boston-based law firm Goodwin Procter LLP.
3. Update your stock ledger
Once you’ve changed the ownership share percentages and drawn up an agreement, lawyers recommend officially recording this new information into the company’s stock ledger. A stock transfer power gives a transfer authority—which can be a law firm or the company itself—the power to record the transfer of stock on the corporate record. The company should also retrieve your original stock certificate to cancel it. You’d then be issued a new certificate stating the amended number of shares you own.
For example, if you’re buying back shares from your partner, your company would need to get back certificates from both you and your partner, cancel out those certificates, and stamp them as canceled. The business would then issue new stock certificates with the correct amount of shares. Your company or the transfer authority would update the stock ledger with the new stock certificate numbers, which would list the owner of that certificate, the number of shares owned, and the date of issuance.
4. Update your incorporation paperwork
Your business most likely is incorporated in your home state—the state where your company is headquartered. Once you change your ownership shares, you’ll need to change the original article of incorporation and file this with your state.
Reasons Why You Might Consider Changing Your Ownership Percentages
Now that you have a basic roadmap for how to go about changing your ownership shares, it’s a good time to consider some common reasons why you’d want to do so in the first place.
You’re putting more money into the business
Say, for example, you started your company with a friend or family member, and initially you each contributed an equal amount to start up your business. As the company grows, more capital is needed, and you have the money to contribute but your partner does not. You decide you want to contribute the funds, but you’d also like a bigger stake in the company to account for your larger monetary investment.
You’re quitting your day job to work full-time
In this situation, you and your partner each own 50% of the business. Up until now, neither of you has been able to afford to leave stable jobs to devote 100% to the growing business. Now, however, your personal life will allow you to take a risk, quit your job, and work at the company full-time. In order to do this, you’ll want to own more than 50% of the company.
You’re asked to join a business but they can’t afford to pay you
This is a common scenario with small companies, and a good opportunity to take a percentage of the company shares in exchange for your work. For example, say you’re a graphic designer and the company needs new logos. You have a valuable skill that doesn’t require that you quit your job, and can instead do some work on the side and get a percentage of the company’s profits.
You may want to change ownership percentages to qualify for a loan
If your company decides to take out a small business loan, the lender will typically look at the financial qualifications of all owners holding more than 20% of the company. If you fall under this criteria, your credit will be considered and you’ll likely be asked to personally guarantee the loan. In order to qualify for many loan programs with lower interest rates, your credit score will also need to be above 620.
Sometimes businesses will opt to shift ownership percentages so that the company can access funds at the best interest rates. But this isn’t always a wise way to go, cautions Anna Dodson, partner at Goodwin Procter LLP.
Dodson also cofounded Goodwin’s Neighborhood Business Initiative in Boston, which provides pro bono business legal services to low-income entrepreneurs. Changing ownership percentages just for appearance’s sake for loan programs can get murky, especially when nothing else has changed in terms of your investment stake or the amount of work and capital (or other property) you’re contributing to the company, says Dodson.
“If there is a big gap between how you actually do things within your business and what your organizational papers say, this could be a problem,” says Dodson.
Instead, if you need a loan, another option could be to seek out a lender that will qualify you with your current ownership percentages. This may mean higher interest rates, and although this isn’t ideal, it could help you build better credit in the long-run. As your credit improves, you could pay off the higher interest loan and eventually move into a better type of loan program without changing your ownership stake, according Andrea Ierace, manager of lending at Accion East in Cambridge, Massachusetts. “At the end of the day, we don’t want to put anyone in debt,” says Ierace.
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from Fundera Ledger https://www.fundera.com/blog/2015/11/11/ownership-percentages/