How to Organize the Sale of Your Business or Company
The seller has a vested interest in securing the sale legally, financially, and fiscally.
From a tax perspective:
The sale of a business or company shares often generates capital gains for the seller. It is in the seller’s interest to verify, before the sale, the amount of the capital gain and any exemptions they may be eligible for. They will do this with their usual advisor, most often their lawyer or accountant.
Capital Gains Tax Exemptions
The sale can generate a capital gain for the seller. The lawyer’s role is to anticipate and optimize the tax implications of this transaction for both the seller and the buyer.
The seller must close their accounts and declare the income for the completed fiscal year for the calculation of personal income tax (IR) and/or corporate income tax (IS). The deadline for declaring the sale varies between 45 and 60 days depending on the seller’s legal or tax status.
Assumptions:
If the seller is subject to Income Tax:
a distinction must be made between short-term capital gains (business ownership period less than 2 years) and long-term capital gains (business ownership period more than 2 years).
– In the case of a short-term capital gain, i.e., a business or shares acquired more than 2 years ago:
The capital gain is generally taxable as part of the business owner’s or company’s income subject to Income Tax. It is therefore subject to income tax (at the seller’s current progressive tax rate).
Thus, its amount is added to the seller’s business income.
Example: Annual business income = €80,000 + €60,000 taxable capital gain = €140,000 taxable income
The tax rate is progressive:
From €10,226 to €26,070 of income = 11%
From €26,071 to €74,545 = 30%
From €74,546 to €160,336 = 41%
€2,867.70 + €14,542.20 + €26,836.14 = €44,246
The amount of capital gains tax payable will be €44,246.
– In the case of a long-term capital gain (business or shares acquired or held for more than 2 years): the capital gain is subject to the flat tax, a single fixed-rate levy, at a rate of 30% (income tax at 12.8% and social security contributions of 17.2%).
Example: *Capital gain from the sale: €60,000. Capital gains tax on the sale of the business or shares = €18,000
*Business income 2022 = €80,000
Income tax on business income: €2,867.70 + €14,542.20 + €2,236.14 = €19,646.04
Therefore, the total income tax payable by the seller in this example will be €37,646.04.
The debts or liabilities of the company should not be taken into account when calculating the amount of taxable capital gain (CAA Nantes 1-4-2022 n° 20NT03628).
- If the company is subject to corporate income tax:
The capital gain from the sale of the business or shares is included in the accounts of the owning company and therefore in the profit for the current fiscal year. There is no distinction between short-term and long-term gains, i.e., the length of time the asset has been held.
This gain will generally be taxed at the standard tax rate applicable to it:
– 15% up to €38,120 of profit (under the conditions stipulated by the 2018 Finance Law).
– Fiscal year beginning on or after January 1, 2019: 15% up to €38,120, 28% from €38,120 up to €500,000 of taxable profit, and 31% above €500,000.
– Fiscal year beginning on or after January 1, 2020: 15% tax rate up to €38,120 and 28% tax rate above that amount.
– Fiscal year beginning on or after January 1, 2021: 15% tax rate up to €38,120 and 26.5% tax rate above that amount.
– Fiscal year beginning on or after January 1, 2022: 15% tax rate up to €38,120 and 25% tax rate above that amount.
Thus, in 2022, if the business owner has €140,000 in profits, including €80,000 in profits from the business activity + €60,000 in capital gains, the tax will be €5,718 + €25,470 = €31,188.
For companies with a turnover between €763,000 and €250 million, the 15% threshold does not apply: the rates of 28% up to €500,000 and 31% for profits exceeding €500,000 (for 2019), 28% for 2020, 26.5% (for 2021), and 25% (for 2022) apply from the first euro.
For companies with a turnover exceeding €250 million, the 15% threshold also does not apply: in principle, the rates of 28% up to €500,000 and 33.33% for profits exceeding €500,000 (for 2019), 28% for profits from €0 to €500,000 and 31% for profits exceeding €500,000 for 2020, 27.5% (for 2021), and 25% (for 2022) apply from the first euro (for these last two rates, the 27.5% and 25% thresholds apply from the first euro).
In certain cases, corporate income tax (CIT) is increased.
The capital gain realized from the sale of a business is calculated using the following formula:
Capital Gain = Sale Price – (Purchase Price – Depreciation).
If the sale price is €300,000 – purchase price €160,000 – depreciation €20,000: the capital gain will be €140,000.
If the seller originally established a business or purchased a lease, the purchase price is €0. Therefore, the capital gain will be the full sale price: €300,000.
Several other capital gains tax exemptions exist, including:
3-1- Capital gains tax exemption based on business revenue: The seller is fully exempt if they have been engaged in the sale of goods, objects, supplies, and food for takeaway or on-premises consumption, or the provision of accommodation (excluding furnished rentals), for 5 years and if their annual revenue is less than €250,000 (€90,000 for other businesses or those earning non-commercial profits).
The seller is partially exempt if revenue is between €250,000 and €350,000 (€90,000 and €126,000 for others) (under the conditions of Article 151 septies of the French General Tax Code).
3-2 – Exemption based on the value of the business sold:
There will be a full exemption on the capital gain generated by a business whose profits are subject to income tax, or by a company subject to corporation tax (which meets certain revenue threshold conditions):
- if the price of the assets sold or their market value (to which are added capital charges and compensation stipulated for the benefit of the seller) is less than €500,000
- and the business has been held for more than 5 years, except for real estate (under the conditions of Article 238 quindecies of the French General Tax Code, as amended by Article 19 of Law No. 2021-1900 of December 30, 2021, the Finance Law for 2022).
The exemption is partial when the price or value is between €500,000 and €1,000,000.
3-3 Exemption upon the retirement of the company director:
Capital gains realized upon the sale of a business subject to income tax are exempt from capital gains tax upon the retirement of the director if the following conditions are met:
- The business, craft, agricultural, or professional activity must have been carried out for at least 5 years at the date of the sale;
- The executive must cease all functions within the sold company and claim their retirement benefits within two years before or after the sale. This period is extended to 3 years for individuals who claimed their retirement benefits between January 1, 2019, and December 31, 2021, when this retirement precedes the sale.
The manager must not hold, directly or indirectly, more than 50% of the rights or shares of the acquiring company. (Article 151 septies A of the French General Tax Code)
The exemption applies to all capital gains, short-term or long-term, realized upon the sale of the business or company, with the exception of capital gains on real estate.
This exemption is reserved for business capital gains (BIC: Industrial and Commercial Profits, BNC: Non-Commercial Profits, Agricultural Profits: BA) subject to income tax.
However, social security contributions on the exempted capital gains remain due.
II- From a financial perspective:
Sellers are advised to have a professional conduct a financial and social audit before selling their company or business to determine its fair market value.
This financial audit will cover the company’s accounts as well as its employment contracts.
If they fail to do so, they risk the buyer canceling the sale and being required to fully refund the purchase price on the grounds that the price of the company or the shares they bought is incorrect.
If a financial and social audit has been conducted, it must be disclosed to the buyer.
- Debts:
The sale of a business offers a distinct advantage to the buyer because the liabilities are not transferred to them. The price paid by the buyer upon signing the sales agreement is held in escrow for a few weeks to cover the seller’s debts.
Debts most often stem from loans to credit institutions, suppliers, and social security contributions and taxes.
The general rule is that the buyer is not liable for the seller’s debts and cannot be held responsible for them.
Conversely, if the buyer purchases shares in a company, the company itself, regardless of the shareholders, is responsible for paying its debts. The buyer can protect themselves by requesting a liability guarantee from the seller, covering any liabilities incurred before the sale that come to light afterward. The seller must disclose all of the company’s debts at the time of the share sale; otherwise, they risk having to reimburse the buyer, either partially or in full, for the purchase price, or at best, for the debt itself.
The seller therefore has an interest in declaring all debts they have or may have at the time of sale, and often in reducing their amount so that the company being sold is not indebted at the time of the sale.
The seller should also pay close attention to the lease terms, as they often include a clause making the buyer jointly liable for rent payments for up to three years. If such a clause exists, the seller should request a release from joint liability at the time of the sale. To do this, they should propose to the landlord that the buyer enter into a new lease at the time of purchase.
- Assets:
The buyer should also ensure that the assets listed on the balance sheet exist, are consistent, and have the value indicated in the balance sheets:
– equipment, furniture, tools…
– customer base, brand, trade name, lease rights, employment contracts, literary, artistic, and industrial property rights (patents), domain name, current contracts;
If necessary, the seller will conduct a legal, social, and financial audit with their lawyer and accountant to analyze each element of the business assets. This audit will ensure their validity, consistency, and value, thus avoiding unpleasant surprises such as: obsolete equipment of significantly lower value, inflated accounts receivable, fictitious or undeclared employment contracts and salaries, inaccurate inventory, and issues with the lease (renewal, rent and charges, etc.).
It is therefore advisable to value each element in the sales agreement.
In the case of a sale of company shares, the buyer will often request an asset guarantee from the seller to ensure that each asset sold (equipment, business assets, etc.) has the value declared in the sales agreement.
- The Income Statement and Profitability Figures:
The audit will then use the income statement to determine whether the business is profitable and whether it allows the company to generate a profit, thus enabling it to pay its partners or repay a loan taken out to acquire the business or invest.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a financial indicator reflecting the business’s operational performance. A negative EBITDA indicates a gross operating loss, meaning the business is not profitable. Conversely, the higher the EBITDA, the more profitable the business. EBITDA can be calculated in different ways: based on revenue, added value, or net income.
EBITDA Calculation Formula from Revenue:
EBITDA = Revenue (account 70) – Cost of Goods Sold (account 60) – Cost of Goods Sold (account 61 and 62) + Operating Subsidies (account 74) – Personnel Expenses (account 64) – Taxes and Similar Payments (account 63)
EBITDA can also be calculated from Net Income:
EBITDA = Net Income + Financial Expenses – Financial Income + Extraordinary Expenses – Extraordinary Income + Depreciation and Amortization – Reversals of Depreciation and amortization – other operating income + other operating expenses.
EBITDA can be calculated from value added.
EBITDA = Value Added + operating subsidies – personnel expenses – taxes, duties, and similar payments.
EBITDA thus allows us to see the company’s profitability and its:
- Gross profitability rate = EBITDA / invested capital;
- Profitability rate = EBITDA / Revenue (excluding VAT);
- Margin rate = EBITDA / Value Added;
- Free cash-flow = EBITDA – Income tax + Change in working capital + Change in investment.
Free cash flow highlights the surplus cash available to pay shareholders or to make investments for the company.
From a legal standpoint:
* The lease:
The prospective buyer will, of course, verify all the clauses of the lease, and in particular the permitted business activity and the remaining term of the commercial lease.
The lease is, of course, transferable in the event of a business sale.
The seller will often benefit from obtaining a lease renewal before the sale, as indicated above, unless the transaction involves the transfer of company shares.
If it is a lease transfer, the landlord’s agreement must automatically be obtained.
If it is a sale of the business assets, the transfer is unrestricted, unless the lease stipulates otherwise. If the lease contains a clause requiring the landlord’s consent to the sale of the business assets, the landlord must respond in good faith and within a reasonable timeframe to these requests. If the landlord fails to respond, and this lack of response prevents the seller from transferring the lease for valuable consideration, or from seeking other potential buyers or negotiating the refusal, then the landlord will be liable for the damages caused to the commercial tenant. (CA Bordeaxux, February 20, 2019, No. 18/04897, Selas Egide v. SCI PMP). This can be the case with repeated and systematic refusals by the landlord.
If the lease is temporary or if the business relies on a temporary occupancy permit granted by a municipality or other public body, the rules differ because there is no automatic right to renewal.
*Other Contracts of the Business
3-1- Contract Monitoring
Some contracts are generally transferred with the business assets, for example, employment contracts.
In this regard, the seller is advised to keep the employee attendance register and employment contracts up to date so that they can be presented to the buyer as transparently as possible.
Property damage insurance policies are generally transferred to the buyer of the business.
The same applies to publishing contracts.
Other contracts are not transferred to the buyer of the business (for example, beer supply or distribution contracts (unless there is a tripartite agreement), personal insurance contracts, etc.).
Finally, of course, if it is a sale of shares or stock, all contracts remain in effect for the benefit of the same company.
3-2-Securing the business’s or company’s relationships with credit institutions and suppliers.
The manager must also take maximum precautions to secure the sale of a business or company shares with banks, credit institutions, and suppliers.
Credit institutions and suppliers support businesses and companies daily in financing and completing their acquisitions and investments.
A company’s reliability is important, and therefore, the security of contracts is crucial.
Risks of an Unsecured Sale of a Hotel, Restaurant, or Catering Business
1* The seller has a vested interest in securing the transaction as much as possible to avoid the buyer’s request to have the sale declared null and void and thus receive a full refund of the purchase price. The buyer has five years to pursue this action.
This can happen when the seller has withheld essential information. Most often, this involves business information about the operation of the business or company.
Among the most frequent examples:
* Inflated sales figures by the seller,
* Failure to disclose the loss of a contract with a major client,
* Accounts receivable or inventory levels lower than declared,
* Profitability declared by the seller of the business that does not reflect reality (Cass, Commercial Chamber, February 14, 2018, No. 16-24.555)…)
* Clause in a condominium bylaw that excludes businesses likely to disturb other co-owners through noise and cooking odors. Indeed, this information is crucial because it alters business projections and therefore the sales figures of the buyer for whom operating a restaurant was a key factor (Court of cassation, January 6, 2021, No. 18-25.098: existence of a general meeting prohibiting previous owners from operating after 8 p.m.).
Any piece of information can be crucial if it influenced the buyer’s decision to purchase the item.
The buyer will therefore receive a full refund if the sale is cancelled.
* After the sale, the buyer may request a price reduction if they discover that information was withheld from them (within 5 years under the right of rescission or within 2 years under the warranty against hidden defects (Articles 1641 seq of the French Civil Code)).
The seller also has an interest in securing the transaction as much as possible to prevent the buyer from requesting a partial refund.
* The buyer may claim and obtain damages.
The seller has a pre-contractual obligation to provide information that is essential for the buyer’s consent (Article 1112-1 of the French Civil Code).
If the seller fails to fulfill this obligation, the buyer may also claim additional damages.
It is crucial to pay particular attention to the commitments contained in the sales contract, especially non-compete and non-re-establishment clauses for the seller’s business owner or manager in the same sector, otherwise the seller may be liable to pay the buyer damages equivalent to the loss of business revenue generated by this unfair competition or failure to re-establish itself (Cass, Commercial Chamber, January 9, 2019, No. 17-20.526).
In conclusion, all the clauses and declarations contained in the deed of sale are therefore important in practice.
It is therefore advisable to consult a lawyer specializing in the sale of businesses or company shares to secure the sale and purchase transaction, both legally, in terms of price valuation, and fiscally, in order to optimize the tax situation for both sellers and buyers.