How is Selling a Business in California Different Than Other States?
Selling your business anywhere is a life-changing event. The sale will likely be the most significant financial event of your life and may even be a large part of your plan for retirement. It’s important that you plan for this event just as carefully, if not more so than you plan for other things in your business. But when selling a business in California, things can be a little more complicated and require more planning than in other states.
The reasons are many. California generally leads the nation in regulations designed to protect the environment, and many of these involve the fact that you must have special licensing and certifications in many types of businesses.
Not only do these regulations and others affect your ability to find a qualified buyer, but there are other laws unique to California that affect how a business is sold. There are legal requirements in addition to the fact that you must use an escrow process when selling a business.
These business deals can be complex, but they can be navigated with the help of a Certified Business Broker and with some proper planning ahead of time. Here is some detailed information regarding everything you need to know.
The California Economy
You might ask yourself the question, “If California has so many regulations and it is more complicated to sell a business there, why are there so many businesses in California?
The answer to that question is quite simple: there are a variety of industries in California, and the economy is strong. First Research provides some amazing statistics.
- State job growth rose 1.8% in October 2019 from a year ago; national job growth rose 1.4%
- State unemployment averaged 3.7% in October 2019; the national average was 3.6%
- Personal income rose 5.2% to $2635.3 trillion in Q2 2019 from a year ago.
- Tax revenue increased by 8.3% in Q2 2019 from a year ago.
The area defined as Southern California, if it was a country rather than part of a state, would have the sixth-largest economy in the world. Northern California is home to a large portion of the tech sector and Silicon Valley. The Central Valley in California produces about 40% of the agriculture products consumed in the United States. The manufacturing industry is robust in comparison to many other parts of the country.
Of course, that results in a variety of support industries as well. From HVAC and custom home remodeling to medial practices and auto repair shops, there’s no end to the types of businesses that can be operated successfully in California.
To do so, though, it is necessary to know that there are challenges to doing business here.
General Challenges of Doing Business in California
The specific challenges you will face in California depend in large part on your particular business. Here are some examples:
- The minimum wage is higher than in many other states. If you hire entry-level workers at this pay rate, your bottom line will be affected, and business buyers will need to be aware of this.
- In 2020, the California Consumer Privacy Act is being put into place. This act goes further than GDPR in some areas and not as far in others, but it is likely a precursor to Federal action on consumer privacy.
- California Assembly Bill 5 (often abbreviated AB4) went into effect this year as well, and it regulates which workers can be considered independent contractors and which ones will have to be considered employees. If you normally sub-contract work in your business, you will want to pay close attention to this change in regulation.
- Changes in business technology that originate in Silicon Valley disrupt industries closest to them in California first, often a pressure point for businesses to keep up with their competition.
To a new buyer just moving into California they can seem daunting. This can be a factor when selling your business.
The California Consumer Privacy Act
Before you read the first part of the act and think it does not apply to your company because you don’t have over $25 million in annual revenue, look at the other requirements. The truth is, even if businesses are located in other states, but do business with California residents, they must also comply. Here are some other conditions of the act:
- Companies of any size that have personal data on more than 50,000 people,
- Companies who collect more than half of their revenue from the sale of personal data.
It is important that businesses of all sizes understand this law and how it could affect them.
This law essentially forbids the gig economy in California on several levels, and some think it is a serious mistake on the part of the state. While that remains to be seen, what is important is to know that if you employ drivers who are independent contractors, and your main business is driving and delivery, you must make those contractors employees. This affects Uber and many other companies.
The only way you can have a freelance contractor is if they do not do the thing that your business primarily does. So a freelance writer can write content for a pharmaceutical company, but they cannot create content for an SEO company that regularly writes content for clients. In that case, they must be employees.
While many home builders and other contractors already use an employee model, if they do not, they could be affected by this legislation dramatically. If you use this kind of contract labor, a buyer needs to understand how this law will affect them going forward.
These are not the only challenges that face California business owners. There are several more.
Licensing for Specific Industries
The high level of consumer protection in California means that there are licensing requirements for common types of businesses. When you are selling that type of business, that means you have to be more specific when looking for a qualified buyer. In some cases, the buyer can hire someone with the correct certifications and licenses, but in others, they will need to have those items themselves.
Here are some examples and what they mean.
The Construction Industry
To own and operate a business in the construction industry, the owner must be licensed by the Contractors State License Board of California. The construction industry is defined as “businesses and individuals who construct or alter any building, highway, road, parking facility, railroad, excavation, or other structure in California must be licensed to perform work if the total cost (labor and materials) of one or more contracts on the project exceeds $500.”
The requirements for licensing are stringent and require:
- Completed examination application and $330 fee
- California business license and Tax ID (if LLC or Corporation)
- Fingerprinting Live Scan
- Completion of “Law and Business” exam
- Completion of the secondary trade-related exam
- Completion of the asbestos open-book examination
- An initial licensing fee of $200
- Contractor bond or a cash deposit of $15,000
- Bond of QI (if applicable) of $12,500
- Certificate of Workers’ Compensation Insurance or Certification of Self-Insurance of Workers’ Compensation from the Department of Industrial Relations
- LLC Employee/Worker Bond (if applicable)
- LLC liability insurance (if applicable)
This means that if your buyer already has a license, you have no worries. But if they do not, they face the testing and expense of getting one, and that may take them some time, delaying the sale. Ideally, if you are selling this type of business, you want to find a buyer who already holds a license.
The Auto-Repair Industry
The same is true with the auto repair industry, defined as Businesses or individuals that receive compensation for repairing, altering, or diagnosing malfunctions of motor vehicles. If you do any of these things, as the business owner, you must be licensed by the Bureau of Auto Repair (BAR). There are a few levels of licensure, from a simple brake and lamp station to a smog check station and full auto repair facility.
If the name or address of your business changes, you must inform BAR right away, or if you expand your business, add more bays to your garage, or other actions. The license is not transferrable: any new owner will have to get their own license with BAR.
In addition to this regulation, most auto repair businesses handle hazardous materials and must be licensed to do so by the California EPA. It is vital that a business is in compliance with these regulations. Fines are steep, and most will quickly bankrupt a smaller company.
This can get even more complex. A doctor must be licensed by the State Medical Board of California, and just because they are licensed in another state does not mean they will meet California requirements.
As a business owner, it is important to know this. If you want to sell your medical practice, you must ensure that your buyer either already meets these requirements or is likely to meet them when they purchase the business.
These businesses are also affected by privacy laws and other restrictions.
As you know as a business owner, the manufacturing industry sector is also heavily regulated in California. Depending on what you make, there are EPA regulations, strict labor regulations, and insurance requirements. In order to sell your business, you must find a buyer who knows and understands these regulations, requirements, and expenses.
Local Licenses, Certifications, and Fees
In addition to overall state regulations, many cities and counties have their own regulations regarding licensing, certifications, and even business fees. Your buyer needs to know about these and take them into account before they buy your business.
Despite the challenges of doing business in California, the payoff is worth it in the long run, and this is how you must overcome any reluctance and pain points of potential buyers. This is one of the many reasons for hiring a business broker with experience in these areas.
California and Taxes
So while we are being honest about challenges for business owners and sellers in California, we can’t forget to mention taxes. Taxes in California are typically higher than in other states, and they include several aspects of taxation:
Personal and Corporate Income Tax
In addition to federal payroll taxes and social security, California also has a personal income tax. California also has a corporate income tax rate of 8.84% according to Investopedia. However, there are a couple of unique things about how business owners pay taxes in California.
Federally, small business owners who organize as LLCs and other pass-through corporations to not pay double taxes: in other words, since income passes through to the owner, they simply pay personal income tax on that amount. The Federal government considers that to be double taxation. However, California charges taxes on both corporate and personal taxes even if your company is set up as an LLC. Depending, this policy can potentially double the taxes a small business owner pays the state. Thus how the owner pays themselves a salary and what is counted for business deductions is especially important to minimize tax liability.
The Alternative Minimum Tax
Corporations are not subject to a franchise tax, but they must adhere to an alternative minimum tax of 6.65%. In other words, a company cannot take so many deductions that it pays nothing in taxes. This changes the deductions a company can, would, and should take.
In short, you will need an experienced tax accountant to do business in California and stay in compliance with all the state taxation expectations.
The Collection of Sales Tax
There is a state sales tax, but often there are city taxes as well, and even companies who do business online must charge sales tax, collect it, and report it and remit it to the state, city, or county they are in.
Even business owners from neighboring states like Oregon (with no sales tax) or Arizona (with lower sales taxes) may be surprised by not only the amount of taxes they need to charge and collect but the administrative process for doing so.
When you are selling your business, you need to make sure the buyer understands the complexities that come along with the taxation in California. If they are from another state, you may want to recommend your tax accountant, since they already know your business and the unique tax picture in California.
Additional Challenges to Selling a Business in California
As a part of consumer protection practices, when you buy a home in California, you go through an escrow process. This means that the buyer opens escrow by making a down payment, and a third party (not the buyer or seller or any other party in the transaction) processes the paperwork to ensure that ownership passes from one person to another smoothly and legally and that all money that should change hands at closing does.
While many other states have this practice for buying a home, in California, this process also applies to buying a business. But obviously the process of selling a buying a business is much more complex and requires jumping through hoops of many more regulatory agencies, different lenders including the SBA who have their own requirements, and other entities.
This process includes:
- The bulk sale process.
- The Purchase Price Allocation
- Property taxes
- Franchise transfer fees (if applicable)
- Business license applications
- Getting a clearance from the California Employment Development Department
- Getting a clearance from the California Department of Tax and Fee Administration
- And so much more.
We’ve written elsewhere on this website in detail about how the escrow process works in California. There are different services that are a part of this process, and the best practice is to have a Certified Business Broker who has experience with escrow in California coordinate this process and advise you on your best steps.
Legal Differences when Selling a Business in California
There are several legal requirements to selling a business in California, and many may be things that business owners are not aware of or familiar with.
This is an agreement you have any potential buyer sign before you share with them any detailed information about your business. There are all kinds of reasons you might want your business sale to remain confidential, but in addition, you will want to ensure that none of the vital financial information related to your business remains private.
Make no mistake: this information might be very valuable to your competition and other parties. This type of agreement is essential in the sales process.
Purchase Agreements and Escrow
As soon as your business starts the escrow process, you will want to have a purchase agreement in place to protect both you and the buyer from anyone getting “cold feet” and killing the deal.
Items you may also need:
Other legal items you may also need, depending on the sale of your business, include the following:
- Bill of Sale: The final sale document signed by both parties.
- Assignment of Your Lease: If you are transferring the lease of your property to a new owner, you need this document to protect yourself from any further responsibility for rent or other charges.
- Security Agreements: If you are carrying any financing in the deal, this document ensures that you still retain a lien on the business.
- Non-compete Agreements: If you are leaving the business to continue in the same field and not retire, you may need to sign an agreement that says you will not open the same type of business within a certain distance of this one and for a certain period of time, depending.
A note: California actually has a public policy against non-competition agreements. They are enforceable if reasonable in scope and term when the sale of the business includes goodwill, but if the terms are overly broad in scope and/or have a term that goes beyond 3-5 years, courts may not enforce them. However, it is a sign of good faith to at least make a commitment to your buyer not to compete with them in a similar business once you have sold them yours.
The Complexities of Doing Business in California and Discouraging Buyers
This complexity of buying a business and doing business in California can discourage potential buyers. The typical buyer likes to understand what they are getting with the business, all the things that affect potential profit, and the cost of doing business in exceptional detail.
Many are also intimidated by the buying process itself, since even if they have purchased a business in another state, they may not have encountered laws like those in California.
That is why it is the job of a business broker to help them understand this process, and that in the long run, it is to protect both the buyer and the seller of the business. There are several examples of how this works. For example:
A few years back I helped the buyer of a business close on the sale of a retail T-Shirt business. The seller had not paid a company that had made a set of display stands for the business. Because the supplier had not been paid by the seller and the buyer of the business now owned the display stands, the supplier asked the buyer for payment. Because the escrow process had been followed, the buyer of the business had no liability to the supplier and so no cost was incurred by the buyer.
Are You Thinking of Selling Your Business in 2020?
The economy is currently strong and expected to stay that way through this calendar year. There is no way to project how this might change with an upcoming election. When you know your business is thriving is the very best time to sell. This ensures that you will get the best price and the maximum return for your money.
Because selling a business in California is so different from selling ones in other states, it is essential that you hire the best business broker who knows the ins and outs of the legal process and can help you every step of the way.
With over a decade and a half of experience, Andrew Rogerson and Rogerson Business Services are the business broker for you. Whether you are developing your exit strategy and looking for a business valuation or you are ready to list your California business for sale, we at Rogerson Business Services are here for you. Contact us today. We’d love to be your California business broker.