Mark Pestronk
Q: I am a home-based travel advisor, and I also retain a trusted, experienced advisor as a sub-IC. Over the years, we have built up my client base quite successfully. I make a good living, but I would like to retire. I would like to turn over my business to the sub-IC in return for a percentage of the revenue in future years. Does such an arrangement sound like a viable plan? If so, how would it be structured? I don't have any real assets, so a "sale" of my business to her does not seem appropriate.
A: You do have assets; they are intangible but valuable assets, which can be called your book of business, your client list or the goodwill of your business; all three mean the same thing. Under a well-drafted agreement, you would be selling those assets to your sub-IC.
If you do not operate your business as a corporation or limited liability company (LLC), you are a sole proprietorship. If your sub-IC is also a sole proprietorship, then the agreement between you two would be an asset purchase agreement under which your sole proprietorship sells its intangible assets to her sole proprietorship.
Before the sale goes through, she should have her own attorney representing her interests. The attorney would probably recommend that she establish her own LLC, which would then be the buyer of the assets.
The biggest advantage of structuring the transaction as a sale of your business is that the purchase price (i.e., the percentage of revenue paid to you each year) would be long-term capital gains income, which is taxed at 0%, 15% or 20% at the federal level, depending on your total taxable income and your marital status. In most cases, these rates should be less than the rates at which your ordinary income (such as commissions and fees) is taxed.
The second big advantage of an asset sale is that you could retain a lien (also known as a security interest) on the assets, which would allow you to repossess the business if the buyer defaults by not making the required payments.
Since it is unlikely that your sub-IC can afford to pay for the business in one lump sum, the key remaining question is what percentage of the buyer's revenue she should pay you each year and for how many years. There is no established formula, but from your point of view, a higher percentage paid over a smaller number of years would probably be preferable to a lower percentage stretched out over many years. I say "probably" because some sellers like the idea of a pension requiring the buyer to pay a small percentage each year as long as the seller lives.
A final advantage of an asset sale is that you can provide that only a certain percentage of the ownership of the business would transfer each year. You could even provide that ownership would not transfer at all until after the final payment, although that would be unusual.