Peter Marshall Bsc (Econ) BA MBIM is a Fellow of the Society of Business Teachers, and an experienced educator in business subjects. He is also a prolific author and his books have been translated and sold worldwide. He lives in London, UK.
Three methods of ‘going limited’
A sole proprietor or partnership may wish to change the status of its business entity to that of a limited company. If so, it must draw up a balance sheet for the existing business and form a new company to purchase it at an appropriate price. The new company can pay the seller (sole proprietor or partnership) in any of three ways:
- 1.Buying paid up shares. If the value of the business is say £100,000, then the share capital of the new company will be registered at at least that figure. The seller will transfer his business to the company in exchange for an equal value, not in cash, but in shares.
- 2.Mixture of shares and debenture. The seller may, on the other hand, wish to accept only part of the payment in shares, and the other part in the form of a debenture. In other words, he would be selling the second part for money—but giving the company time to pay (debentures are a type of secured and usually long-term loan).
- 3.Selling shares to other parties. Some of the extra cash raised by this means can then be used to buy some of the assets from the former owner (sole proprietor or partnership).
Adjustments to the balance sheet
If outside parties are becoming involved, they may not agree with the various asset values shown in the business’s balance sheet. They may for example disagree with the figures for bad debts provision, or with the listed value of stock or goodwill. Adjustments then need to be made to these values to satisfy everyone concerned.
You would need to make a corresponding adjustment to the capital account on the balance sheet of the business before it was bought by the limited company. When all has been agreed, we simply need to record the opening figures in the books of the new company.
There will be two fundamental differences between those entries and the details of the closing balance sheet of the business purchased:
- The capital in the opening balance sheet of the limited company will be analysed into shares (rather than into proprietor’s or partners’ capital). It will not show the profit or the proprietor’s drawings for the period up to the takeover.
- Provision for depreciation will not feature in the opening balance sheet of the new company since it will have purchased the assets at their ‘written down value’.