Saturday, December 3, 2005

While I wait to see if my business partners will eventually let me know whether they're going to make me an offer, I thought I'd share what I know about the "Goodwill Clause" my tax attorney told me.

The first thing I need to say is that this isn't a clause that will work for just anyone. For instance, it wouldn't even work for Jack. My tax attorney told me I'd be eligible for it for several reasons, including (a) I founded the company, (b) I give almost all of our public seminars and it's been my name in the media, and (c) when clients -- at least our large clients -- think about our company, they think about me. I've even heard stories that when people can't remember the name of our company they always refer to it as my company.

Given these statements, the tax attorney said I would be eligible to qualify for a Goodwill Clause when selling my business interest. I've actually forgotten most of what my tax attorney had to say about this clause, so I've just dug through the notes I made during my meeting with him. Here are the bullet points from those notes:

  • General rule: "Ordinary income is bad". Don't want to get $ as a consulting following my sale of the compaby because that is ordinary income. My main lawyer suggested getting paid as a consultant after the sale, but the tax attorney said no, you're eligible for this goodwill option.
  • The phrase he used is something like "we want to characterize the purchase price as goodwill."
  • The very important point: Payments characterized as Goodwill are taxed at 15%.
  • I want as much of the sale price as possible to be characterized as goodwill. Not all of it will be eligible for goodwill because of my basis in the company.
  • Regarding getting paid, he strongly recommends that I get all the money up front, but if I really have to, I can receive installment payments, and these can still go against goodwill.
  • Whoever buys my interest won't like this, because goodwill is depreciated over 10-15 years.
  • Other money can, and should, go against my basis. For instance, if my basis is $60K, I want $60K or more to go against that. In this case the basis reduces what is effectively a capital gain.

I'm hoping I can get away with dropping this on the partners because, as you can see, it is a little complicated, and I won't even claim to understand it all at this time. So, I won't be lying when I say I'm a little confused about this point.

Business capital accounts

On a related note, I haven't written much here about capital accounts. Our business is organized as an LLC, and each of the partners has something referred to as a "capital account". This gets into how money is distributed to partners in an LLC. I'm not going to get into it much here, other than to say that we've been more or less distributing our income quarterly as we normally do. I can see how this could be a very real problem for other businesses to deal with when you have two business partners not talking to each other like Jack and I, so if you're looking at selling your own business, for the most part I suggest trying to keep distributions as normal as you can. (Of course how that works will vary by circumstance, and who owns what percentage.)

As a final note about capital accounts, I've made it clear to my business partners that they shouldn't look at my capital account at all. Another term of the deal I may not have mentioned yet is that when I sell my interest, I expect the company to cut me a check for the amount in my capital account, or at least the amount the accountant says I am officially due. For instance, I may have a $100K balance in my capital account right now, but anyone who buys my interest doesn't get a dime of that, unless of course they want to pay me an additional $100K for it.

It's amazing what you learn in the process of selling a business.

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