Letting go can be hard to do, whether you’re a parent watching a child head off to college or an entrepreneur planning to wind up a business. But preparation can make a hard process a little bit easier.
There are three main ways a founder can leave a business. You can transfer it to family or other successors; Larry Elkin has discussed this route in Sentinel on multiple occasions, including his introduction to the Palisades Hudson Financial Group Management Board earlier this year. You can also sell it. My colleague David Walters wrote the comprehensive article “What To Expect When Selling Your Business” for this newsletter a few years ago.
But many business owners do not plan to create a multigenerational enterprise and have no interest in selling the business whole. Instead, they plan to walk away and let the business end with their departure. This is a perfectly valid choice, especially for “owner dependent” businesses such as some law and medical practices. The main goal is for winding up your business to be a conscious decision, rather than an accident due to lack of planning.
If you are a sole proprietor or the single owner of a limited liability company, the choice to wind up the business is solely up to you. If your business is a partnership, a multi-owner LLC or a corporation with multiple shareholders, the future of the business becomes a group decision. In that case, you should document the decision to end the business in writing, and comply with any applicable rules in your articles of organization. For instance, you may need to document the characteristics that led you and your partners to conclude the business is a poor candidate for sale or transfer.
This article focuses on planning to wind down a business voluntarily. While many of the individual steps will be the same for businesses forced to liquidate due to bankruptcy or other external pressures, that process may look slightly different overall from the one I describe here.
Just as in cases where you plan to sell or transfer your business, it is never too early to start planning for the day when you will begin to close your business down. The more you plan in advance, the more smoothly the process will proceed when the day for winding up the business eventually arrives.
The first major step will be to ensure you understand all applicable federal, state and local laws that apply to ending your business. Because shutting down a business is no less complex than starting one, you will want to include experts in your planning process, including a knowledgeable attorney and a tax expert.
Depending on your personal financial situation, you may also want to coordinate the end of your business with the rest of your estate plan. This coordination is especially important if you are a sole proprietor or if you run a family business, in which case a significant portion of your individual wealth and your family’s potential income after your death may be tied to the enterprise. Make sure you take a wide, comprehensive view of where the plan to dissolve your business fits in your overall long-term financial plans.
Your business’s structure will also determine some of the factors involved in shutting down the enterprise. If you are a sole proprietor, the decision to one day wind up your business rather than transfer or sell it generally means you will likely structure your affairs in order to maximize your current income and retirement savings. Especially as you approach the time you plan to exit, reinvesting in the business will be a secondary concern at best.
In a partnership, LLC or corporation, business owners will need to be especially careful to understand the laws that govern the end of the particular type of organization in question. Owners will also need to abide by any rules in the company’s articles of association or partnership agreement. For example, partners will likely need to create a formal dissolution agreement, in which they agree on each partner’s duties in winding up the business and the proposed timeline for ending the partnership. C corporations are likely to face extra requirements when winding up, due to state laws; many states have adopted the Model Business Corporation Act, which includes a variety of detailed provisions about business dissolution.
The Beginning Of The End
When you approach the time you want to wind up your business, you should assemble a team of professionals to help guide you, and your fellow owners if any, through the process. Ideally, at least some of them will be the professionals you consulted in creating your dissolution plan. At a minimum, you should involve your attorney and your tax professional. Depending on your situation, you may want to include your personal financial or estate planner as well.
Once your team is ready, the next step will be to begin spreading the word. Early on in the process, alert your creditors and your customers that the business will be shutting down. Depending on your state, you may need to give creditors a minimum amount of time to file claims against the business. Some states may require you to post a public notice in a newspaper or online. In this stage, you should also try to fulfill any outstanding jobs or contracts. For agreements you cannot honor before closing, negotiate early termination or arrange to pay cancellation provisions on contracts that specify them. In some cases, it may make sense to offer clients or customers a partial refund for services they paid for in advance that you will not be around to provide.
If you have employees, you should give them as much notice as possible of the business’s imminent end. This will allow them to start looking for new jobs. If it is important that key staff members stay on until the end, consider offering them a bonus if they commit to stay through the dissolution process. For all employees, prepare to pay out the cash value of any accrued vacation and any other state-required compensation with their last paycheck. State law determines how soon you must issue final paychecks; in some states, these are due by the final day of operation.
You will also need to contact your commercial insurance agent to let your insurer know that the business is shutting down. In some cases, you may want to consider extending the business’s insurance for a reasonable amount of time after the enterprise stops operating, in order to shield you and any other owners from potential liability. You will need to investigate your state’s statute of limitations to understand how much coverage is prudent for you.
For businesses that have a physical location, it is also important to give your landlord plenty of notice. State laws vary, but in most places you will need to give a minimum of 30 days’ notice. If you handle the utilities yourself, you should also remember to close those accounts in the winding up process.
Corporations, LLCs and limited partnerships must notify the secretary of state that the business is drawing to a close. General partnerships are seldom required to do this, but it is often still a good idea; sole proprietors do not need to send such a notification, however. Any business that holds a Certificate of Authority to transact business will also need to surrender it to the state. If you have a trade name, take steps to notify the proper authorities that you are discontinuing its use. In your contact with local, state and federal authorities, winding up a business will not be unlike starting a business in reverse. You should notify each agency that issued you a registration, permit or license that your business is ending.
Once you have notified the interested parties, you should begin the process of sorting out your business’s assets and obligations. If you are largely a retail business, you will want to get a head start on selling off your inventory, including “going out of business” sales or other promotions. Be mindful of bulk sales laws in your state that may apply; these laws may require you to notify your creditors a certain number of days before you sell off your inventory.
In addition to your inventory, you should consider the best ways to liquidate your business assets. Your approach will depend on the types of assets involved, your business’s structure, and how much liquidity you will need to service debt and pay shareholders or co-owners. If you are a sole proprietor and debt is not an issue, you may also consider donating certain assets, such as a dedicated vehicle, to charitable institutions that can use them.
You should also take time to collect any outstanding receivables. In the case of money that has been owed for a significant amount of time, you may want to offer discounts for immediate payment. If you have accounts you cannot collect as the business nears its end, consider selling them to a third party if you can legally do so.
For businesses that wind down voluntarily, it is still important to be mindful of creditors. Prioritize the business’s debts in such a way that it protects you from personal liability, and ask your creditors to provide letters confirming that your bills are paid in full. If you have a bank loan, be aware that as soon as you inform the bank that the business is in the process of closing, the bank can call your note due immediately; as such, you should time this carefully so that it does not create an unexpected liquidity problem. Once you no longer need them, you should also close your business’s bank account and cancel any dedicated business credit cards.
As the business winds down, you will distribute any remaining assets according to your business’s structure. Sole proprietors or single owner LLCs are straightforward: everything left over goes directly to the owner. Partnerships or multi-owner LLCs should pay each partner an amount equal to his or her capital account if sufficient assets are available. Otherwise, distribute money proportionally based on capital account size. Corporations will divide what remains among shareholders according to the proportion of owned shares.
The Internal Revenue Service offers a portal for small businesses closing up shop (https://www.irs.gov/businesses/small-businesses-self-employed/closing-a-business). As a visit to the IRS website suggests, for some businesses, winding up tax affairs can be a major and complex component of shuttering business operations. But it is important to take the time to be thorough in letting the Service – as well as state and local tax authorities – know that your business is ending.
Your final state and federal income tax returns, on the whole, will look a lot like the income tax returns you have filed in the past. However, unless you are a sole proprietor, you will need to alert the IRS that this return is last. Partnerships and LLCs should check the “final return” box on Form 1065 and report distributed profits and losses on Schedule K-1. Corporations should check this box on Form 1120 and report shareholder allocations on Schedule K-1. For businesses operating in states that require them to collect sales tax, they should also mark their final state sales tax forms as “final” in the way the state in question requires.
If you have employees, your business will need to file its final quarterly or annual employment tax forms (Form 940 for annual returns or Form 941 for quarterly returns). Whichever form you file should also be marked “final.” Your business will need to report withholding information from employees’ final W-2s and report information from any issued Form 1099s for independent contractors. Businesses that generate tips will also need to file final tip income and allocations. And if you offered a Simplified Employee Pension (SEP) plan or a Savings Incentive Match Plan (SIMPLE), you will need to take the proper steps to shut down the plan in compliance with the law.
While selling your merchandise will have no extra tax consequences beyond those of any other sale, you will need to report the sale of any business asset. This is true even when your business is not closing, but may not have come up earlier; if you run an ice cream shop, you regularly sell sundaes, but you may never have sold a soft-serve machine before. You will need to inform the IRS of the asset’s sale price, as well as its adjusted basis (what you paid for the asset less any depreciation). Use Form 4797 to report such sales, and note that they may sometimes trigger tax consequences.
In pass-through businesses such as partnerships, where owners have basis in the business as a whole, closing the business may also have direct tax consequences beyond asset sales. The level of your capital account after the business shutters represents a capital loss. In theory, this amount should be negligible if the business was in a position to distribute sufficient assets to offset partners’ capital accounts; it is even possible that, should the capital accounts end up negative because they were exceeded by distributions, the end of the business could represent a capital gain. Owners with basis in the company should consult a tax professional to make sure gains and losses are properly reported, as the rules around dissolutions are complex.
Finally, if your business has an Employer Identification Number, tell the IRS that it should close the account. And make sure your business has fulfilled any other particular state and local tax responsibilities. Obtain and keep a good-standing certificate from the relevant state tax authority.
Once your business has closed its doors, there are a few final steps you should take. Depending on your state’s laws, you may need to file an additional notice with the secretary of state confirming that all the business’s debts are paid and all its assets have been distributed.
Corporations, LLCs and partnerships also need to take steps to formally dissolve. The specific rules for each structure are governed by state law. In addition, corporations must file IRS Form 966 no later than two months and 15 days after the business closes.
It is wise to keep all records and documents connected to your business for seven years, in case you are audited or face other legal queries about your business’s operation or dissolution.
Properly winding up a business is arguably as complicated as starting one. However, with a comprehensive plan, good communication and a team of professionals to help, there is no reason the end of your business shouldn’t be as successful as its heyday.