Tax Considerations When Bringing a New Partner or Investor Into Your Business

Bringing a new partner or outside investor into a closely held business can provide capital and create opportunities for growth. But changing ownership can also have tax and legal consequences for the business and its existing and incoming owners.

At Martin Pringle Law Firm, we help Kansas and Missouri businesses navigate the legal considerations involved in ownership changes and business transactions. Here are several issues to discuss with your legal and tax advisors before moving forward.

Consider Your Business Structure

The tax consequences of adding an owner depend largely on how your business is structured. Partnerships, LLCs, S corporations and C corporations each have different ownership and tax rules.

For example, S corporations have restrictions on who can be a shareholder. Adding an investor who does not meet those requirements could affect the company's S corporation status. LLCs also require careful consideration because their tax treatment can vary based on their classification.

Before bringing in a new owner, review your entity structure and governing documents with your advisors.

Equity or Debt?

New capital can generally be structured as an equity investment or a loan, and the two approaches have different tax and legal consequences.

Interest on legitimate business debt may generally be deductible by the business, while an equity contribution does not typically create a business deduction. If an arrangement is intended to be debt, its terms should reflect a genuine loan, including appropriate repayment and interest provisions.

Valuation and Ownership Transfers

Determining the value of the business and the ownership interest being transferred is another important consideration. Valuation can affect the purchase price, ownership percentage and potential tax consequences.

For an existing owner who sells part of their interest, the transaction may result in taxable gain. Transferring an interest to another party for less than its fair value can also create additional tax considerations.

Review Your Business Agreements 

Adding a new owner can affect more than taxes. Operating agreements, shareholder agreements and other governing documents may need to be updated to address ownership rights, voting, management authority, profit distributions and restrictions on transferring ownership.

It is also important to consider what happens if the relationship changes in the future. Buy-sell provisions and other exit terms can establish expectations before disagreements arise.

Plan Before the Transaction 

Bringing in a new partner or investor can affect your business for years to come. Addressing tax and legal considerations before the transaction is finalized can help identify potential issues and ensure the appropriate agreements are in place.

Martin Pringle’s Business Law attorneys work with businesses and their owners throughout Kansas and Missouri on ownership changes, business agreements and other legal matters affecting closely held companies.

Contact Martin Pringle Law Firm to discuss your business's needs with an experienced Business Law attorney.