If you're considering converting your sole proprietorship to an ApS company, there are usually several reasons behind this decision, such as the desire to have limited liability. However, before making the switch, it is important to ensure that a limited liability structure is suitable for your business.
If you decide to go ahead with the conversion, you have two options to consider. These options are not mutually exclusive and can be used in combination:
If your business has significant value, it may be a good idea to consider a "tax-free" conversion when converting your sole proprietorship into an ApS company. In such a scenario, the conversion is treated as if the sole proprietorship's assets (including machinery, goodwill, equipment, liabilities, etc.) were being sold to a new ApS.
If the sole proprietorship has a high value - for example, if the revenues are high and there are many customers - then the profit from the sale of the ApS business would also be high. This profit can come from the sale of machinery and equipment, as well as from the sale of customers. Therefore, it is important to determine the value of your customers to understand the total profit from "selling" a sole proprietorship to a new ApS.
Overall, a "tax-free" conversion can be a smart move when converting a sole proprietorship to an ApS, particularly if the business has significant value. It can help to ensure that you are not subject to excessive tax liability and can help to streamline the conversion process.
You need an auditor to make a tax-free conversion
The auditor plays an important role in the conversion process when a sole proprietorship is transformed into an ApS. One of the key tasks of the auditor is to determine the value of the company and to issue an appropriate statement. Additionally, the auditor will undertake the actual process of registering the ApS.
During a "tax-free" conversion, your future tax liability will be deducted from the same profit that you received from the "sale" of the ApS business based on the goodwill that the auditor has determined. The cost of an auditor's services during a "tax-free" conversion usually ranges from DKK 5,000 - 20,000 + VAT, depending on the complexity of the company.
In summary, the auditor's role is crucial during the conversion process, as they determine the value of the company and ensure that the process of ApS registration is undertaken properly. The cost of their services can vary depending on the complexity of the company, but the expense is often worthwhile given the benefits of a "tax-free" conversion.
So why is this type of conversion called „tax-free”?
The term "tax-free conversion" is not entirely accurate as it implies that no taxes are due on the conversion. In fact, the more precise term would be "tax-deferred conversion" because the tax on the conversion still needs to be paid to the IRS at a later date.
However, the advantage of using the tax-deferred conversion rules is that the tax liability is deferred until you sell your shares in the new ApS. Therefore, it's not truly "tax-free" in reality, but you can defer the tax liability until a later date, potentially reducing your immediate tax burden.
If your business has little to no value, a taxable conversion is a more appropriate option when converting your sole proprietorship into an ApS company. When selling a sole proprietorship to an ApS, there may be little to no gain as a result of the sale. As a result, the tax on the sale of a sole proprietorship to an ApS is typically zero or at least very low.
In contrast to the cost of a tax-free conversion option, which can range from DKK 5,000-20,000 + VAT, a taxable conversion can be more advantageous for a small sole proprietorship. This is because the costs associated with a taxable conversion are typically lower than those associated with a tax-free conversion, making it a more cost-effective option for businesses that do not have significant value.
The value of a business is the amount that a buyer would be willing to pay for it. However, because buyers may not always be available, it is necessary to make certain assumptions about the value of a business. One way to assess business value is to look at the difference between its assets and liabilities.
Assets may include things like goodwill, machinery, deposits, equipment, cash, receivables from customers, and bank deposits. Liabilities may include debts, loans, credits, and other obligations. The value of most of these components is typically visible on the balance sheet. For example, if a business owes a supplier €1,000, the value of the liability is usually €1,000. However, for items such as machinery and equipment, it may be necessary to evaluate their present value.
Goodwill is usually valued at 0 on the balance sheet. This is because, when starting a sole proprietorship, there is usually no existing customer base. Over time, as the business builds a customer base, goodwill may increase, but this is not considered an asset on the balance sheet. Therefore, when converting to an ApS, the value of the customer base is often a key consideration.
If a company's customer base has no value on the balance sheet, then the entire value of the customer base will be taxed when the sole proprietorship is converted to an ApS, as the customer base is considered to have been sold to the new ApS. If the customer base was acquired at some point in the past, then it may be necessary to look at the difference between the current value and the value that is recorded on the balance sheet. In any case, the current value of the customer base must be determined before converting to an ApS.
To calculate the value of your company, it is necessary to consider factors such as machinery, liabilities, equipment, and other assets, as well as the value of the company's customer base. There are no set regulations on how to calculate the value of a business, so it is up to the business owner to determine an appropriate value.
When converting a sole proprietorship to an ApS, the business owner acts as both the seller and the buyer. Therefore, the price at which the business is being sold must be documented in some way. This may involve assessing the value of assets and liabilities, evaluating the present value of equipment and other assets, and determining the current value of the customer base. Ultimately, the price at which the business is sold will depend on a number of factors, including its current performance, its future potential, and market conditions.
There are five main methods that can be used to document the value of a business:
Option 1: Use the most commonly used valuation methods in your industry
If there are commonly used valuation methods in your industry that can be used to determine the value of your business, including the value of the company's customer base, this may be a good option to consider. However, it is important to ensure that everything is well-documented, in order to provide evidence of the valuation. This approach is often used in professions such as doctors, law firms, dentists, auditors, and real estate agents, where there are established methods for valuing these types of businesses.
It is important to note, however, that not all industries have established methods for valuing businesses. In such cases, it may be necessary to develop a custom valuation method, or to hire a professional valuation expert to determine the value of the business. Ultimately, the most appropriate method for valuing a business will depend on a range of factors, including the industry in which the business operates, the current market conditions, and the business's financial performance.
Option 2: Use the tax office’s guidelines
The IRS has provided a set of guidelines that can be used to estimate the value of a company's customer base. By using these guidelines, it is possible to arrive at an estimated value for the customer base, which can then be added to other assets and liabilities in order to calculate the overall value of the company.
Using the IRS guidelines can be a helpful way to arrive at an estimate for the value of a customer base, particularly if there are no established methods for valuing customer bases in a particular industry. However, it is important to note that the estimated value derived from the IRS guidelines may not accurately reflect the true value of the customer base, and it is important to consider other factors that may impact the overall value of the business.
Option 3: Use your own way
Estimating the value of a company's customer base using your own method can be a risky approach if your calculations differ significantly from established industry or IRS guidelines. If your estimate is significantly different from the actual value, you may be required to pay taxes on a higher amount than you expected.
To reduce the risk of this happening, it is recommended to seek approval for your valuation from the tax office before converting your business. While this may increase processing time by several months, it can help to provide greater certainty around the valuation of your business and reduce the risk of any unexpected tax liabilities. Seeking approval from the tax office involves submitting documentation detailing the valuation method used, and providing evidence to support the estimated value of the customer base. By doing so, you can be sure that your valuation method is consistent with the guidelines used by the tax office, and avoid any potential surprises down the line.
Option 4: Use an offer from an unrelated person who wants to buy your company
If you have received an actual offer from an unrelated person to purchase your business, this can be used as a basis for determining the value of your company. An offer from an unrelated person provides an objective valuation of the business based on market demand, and can be a useful starting point for negotiations with potential buyers. It is important, however, to carefully evaluate the terms of the offer to ensure that they are fair and reasonable, and to seek professional advice if necessary. By using an offer from an unrelated person to determine the value of your company, you can help ensure that the valuation is based on real-world market conditions, rather than on subjective or untested methods.
Option 5: Get a valuation done by a professional
Another option for determining the value of your company is to hire a professional, such as an auditor or company broker, to provide a formal valuation. A professional valuation can provide a more accurate and objective estimate of the value of your business, and can be useful in situations where there are no established methods for valuing businesses in your industry. The valuation process typically involves a thorough analysis of the business's financial statements, market conditions, and other relevant factors, and may also include a review of comparable businesses in the same industry.
While hiring a professional to provide a valuation can be more expensive than other methods, it can also provide greater certainty and confidence in the value of your business. Additionally, having a professional valuation can be useful in negotiations with potential buyers, as it provides a clear and objective basis for determining the value of the business.
To use the IRS’s guidelines for calculating goodwill, include in the calculation the profit of the last 3 years for a sole proprietorship.
Remember that there are 2 types of profits:
Typically, when determining the value of goodwill, it is recommended to use the profit calculated based on accounting principles, such as GAAP, rather than the profit based on tax rules. However, if your company only prepares its financial statements based on tax rules, it may be acceptable to use the profit calculated based on those rules for the purpose of valuing goodwill.
Regardless of which method is used, it's important to base the calculation of goodwill on the profits of the business over the last three years, before interest and taxes (referred to as "Resultat før renter" in Danish). This can provide an accurate measure of the profitability and value of the business over a sustained period of time, which is important when determining the overall value of the business and its potential for future growth.
If the calculations are done in 2021, we will look at issues such as:
Once you have calculated the profit for the last three years before interest and taxes, it's important to adjust the profit in each year according to various factors that may impact the value of goodwill. These adjustments can include:
After making the necessary adjustments to the profits for the last three years before interest and taxes, the result is called the adjusted profit for each of the three years. The next step is to calculate the average profit of these three regulated profits, with the most recent year being weighted more heavily than the oldest year. This is because the most recent year's profit is more indicative of the current state of the business, while the oldest year's profit is less relevant due to the potential changes in the market or industry.
By calculating the average of the adjusted profits, you can then determine the estimated value of the company's goodwill, which is an important factor to consider when converting a sole proprietorship to an ApS company.
This is done by multiplying the years by the individual factor and dividing by 6:
To calculate the estimated goodwill of a company, first, the adjusted profit for each of the last 3 years is calculated by making adjustments for things like removing an associate's salary, removing depreciation made on previously acquired assets, and removing the extraordinary amount. The average profit of these three regulated profits is then calculated by dividing the sum by 6. If the profit grew from year to year, 50% of the profit growth from the oldest year to the most recent year is added to the result. Then, the salary for a sole proprietor is deducted, which is 50% of the remaining result (but a minimum of DKK 250,000 and a maximum of DKK 1,000,000). Next, 3% of the value of assets (excluding goodwill purchased in the past) is subtracted from the remaining result. To adjust for future expectations, a factor is used based on the life expectancy of customers, which is typically set at 7 years. This factor is 2.83, and it is used to multiply the remaining score to arrive at the calculated estimated goodwill.
The "tax-free" conversion process has a fixed start date of January 1st each year, and can be initiated up to 6 months in advance. This means that a "tax-free" conversion can be made between January 1st and June 30th of each year, and will take effect retroactively from January 1st of the same year.
Regardless of the method used to calculate the estimated value of the company, it's important to consider whether the estimated value is realistic and reflective of what you could actually sell the company for to an unrelated party. If you have doubts about the estimated value, it's recommended to consult with the tax office for guidance. Ultimately, the actual price for the company will be determined by market forces, not just the estimated value.