How to convert a sole proprietorship to ApS in 2023
There can be many reasons why you would want to convert your sole proprietorship to ApS.
Very often, it relates to limited liability or tax considerations.
First, you must ensure that you can run your company in a limited liability structure.
You can read more about the dangers of operating an ApS if it turns out that you are considered the beneficiary and not the ApS by reading our blog here.
You have two options worth considering when you want to convert your sole proprietorship to ApS.
Option 1 – A “tax-free” conversion
When you are in a situation where the company has a significant value, making a “tax-free” conversion often makes very good sense.
The reason for this is:
When the sole proprietorship is converted to ApS, you need to treat it as if the sole proprietorship (machines, equipment, goodwill, liabilities etc.) was sold to the new ApS.
So if the value of the sole proprietorship is high – f.ex. if you have high revenue and many clients, there would be a profit from selling the company to the ApS.
This profit would come from selling the machines and equipment – and also from selling the clients.
The value of the clients we call “goodwill”.
Also, the goodwill of your clients needs to be determined to understand the total profit of “selling” the sole proprietorship to the new ApS.
To make a tax-free conversion, you need an auditor
The auditor will determine the company’s value – including the goodwill – and issue an audited statement relating to the company’s value.
Also, he/she will undertake the actual registration of the ApS.
Once the sole proprietorship is converted to ApS, you will have a future tax liability calculated from the profit that came from “selling” the company to the ApS – based on the company’s value that the auditor determined.
The fee for the auditor when making a “tax-free” conversion is typically in the range of 5.000-20.000 DKK + VAT depending on how complex your company is.
Why is it called “tax-free”, then?
A correct expression would have been a “tax postponed conversion” – since you still owe the tax from the conversion to the tax office.
But when using the rules for the tax-free conversion, you are allowed to postpone the tax until the day you sell the shares in the new ApS.
So, in reality, it is not really “tax-free” – you get to postpone the tax.
Option 2 – A taxable conversion
When you are in the opposite situation where the company has little value, making a taxable conversion often makes very good sense.
It is because:
Even if you sell your sole proprietorship to the ApS, there is little or no profit due to the sale made.
For that same reason, the tax from selling the sole proprietorship to the ApS is either zero or very small.
Compared to the cost of making a tax-free conversion (often 5.000-20.000 DKK + VAT), making a taxable conversion often makes good sense for a small sole proprietorship.
The value of a sole proprietorship
The value of a company is what someone is willing to pay for it.
But since we do not always have a buyer on hand, we have to make some assumptions about the value.
We usually look at the difference between the assets and the liability.
Assets f.ex. consist of
Improvements to leased premises
Receivables from customers
Cash and bank deposits
The liabilities f.ex. consists of
Employee tax debt
Most of these have the value you can see in the balance sheet.
F.ex. if you owe 1.000 EUR to a supplier, the liability value would normally be 1.000 EUR.
You will need to estimate the current value for other things, like machines and equipment.
Goodwill is very often valued at zero in the balance.
That is because when you started the sole proprietorship, then you did not have any goodwill, to begin with.
So you have been building up an increased value of the goodwill of your clients over the years, which is not shown in the balance as an asset.
Typically goodwill is the point of interest when converting to ApS for that very reason.
If the value of the goodwill is zero in the balance, then when converting to an ApS, you will be taxable on the whole value of the goodwill since the goodwill is sold to the new ApS.
In some situations where you have purchased goodwill at some point in the past, we are looking instead at the difference between the existing goodwill in the balance and the current value of the goodwill.
Either way, the value of the current goodwill must be determined before converting to ApS.
How do you determine the value of your company?
To calculate the value of your company, then, in addition to the machines, equipment, liabilities etc., we also need to calculate the value of the goodwill.
There is no law on how the value of goodwill should be calculated.
And in general, if a company were sold to a person not related to you, that price would have to be respected.
However, when converting a sole proprietorship that you own to an ApS that you own, you are acting as both the seller and the buyer.
Therefore the price that you decide to sell for has to be documented somehow.
In general, there are five methods you can use to document the value of your company:
1: Use an existing tradition for valuation in your industry
2: Use the guidelines made by the tax office to estimate goodwill
3: Use your way to determine the value of the company
4: Use an offer from a non-related person that wants to buy your company
5: Use a valuation made by a professional
Option 1: Use an existing tradition for valuation in your industry
If you can find existing traditions in your industry that can determine your company’s value, including goodwill, then you can use this form of valuation.
But make sure the tradition is well documented.
Often this is the case for doctors, dentists, law firms, auditors and real estate agents.
But it is by far not all industries that have established traditions for evaluating the value of goodwill.
Option 2: Use the guidelines made by the tax office to estimate goodwill
The tax office has made a set of guidelines for calculating an estimated value of goodwill.
So you can use the tax office’s estimate of the goodwill and add that to the other assets and liabilities.
Then you will get a calculated value of your company also.
We have also made an Excel sheet you can download and use to calculate the goodwill using the tax office’s guide – please see further below.
Option 3: Use your way to determine the value of the company
This, of course, can turn out to be a bad idea if your calculations are very different from the industry or the tax office’s guidelines.
Worst case, you will have to pay tax on your company’s value that the tax office would later estimate.
To limit the risk, you can request the tax office to approve your valuation before making the conversion.
Doing that will take the uncertainty away.
But it will add a few months to the processing time.
Option 4: Use an offer from a non-related person that wants to buy your company
If you have a current offer on hand from a non-related person, then you are allowed to use this also to determine your company’s value.
Option 5: Use a valuation made by a professional
You can also get a professional – f.ex. a company broker or auditor – to do a valuation for you.
Calculation of goodwill – using the tax office’s guideline
To use the tax office guidelines to calculate the value of goodwill, you need to use the last three years of profit for the sole proprietorship.
Be aware that there are two types of profits
1: A profit that is calculated based on accounting rules
2: A profit that is calculated based on tax rules
As a general rule, you need to use the profit calculated from the accounting rules.
If your company only makes an annual report based on the tax rules (which often happens for smaller sole proprietorships), then you can use the profit calculated based on the tax rules.
The calculation of goodwill is done by taking the profit from the last three years before interests and tax (in Danish, called “Resultat før renter”).
If the calculation is done in 2023, then we would look at
1: Profit in 2022 before interest and taxes
2: Profit in 2021 before interest and taxes
3: Profit in 2020 before interest and taxes
We then would regulate the profit in each year for specific things
1: We remove the salary to a co-working spouse that is not already included as a cost in the profit
2: We remove extraordinary amounts that are not normal (large one-time losses etc.)
3: We remove depreciations done on any previously acquired goodwill
The result you get here we call the regulated profit for each of the three years.
Now we need to calculate the average profit of these three regulated profits, where the newest year is given more significance than the oldest year.
That is done by multiplying the years with an individual factor and dividing with 6
1: Regulated profit in 2022 x 3
2: Regulated profit in 2021 x 2
3: Regulated profit in 2020 x 1
The sum of this is divided by 6.
This gives us an average profit for a year.
Let us call this amount the “result” for the calculations below.
If the profit has increased every year from 2020 to 2021 and 2022, then we add 50% of the profit from 2020 to 2022 to the result.
Then we deduct a salary for the sole proprietor that is 50% of the remaining result – however, a minimum of 250.000 DKK and a maximum of 1.000.000 DKK.
Then we deduct 3% of the value of the assets (excluding any goodwill purchased in the past) from the remaining result.
For the remaining result, we then need to adjust to future expectations.
It is done by looking at the lifespan expectancy of the clients.
As a general rule, this should be seven years.
From the below list, you pick the factor matching seven years – which is 2,83:
|Client lifespan (years)||Factor|
If the client lifespan can be set to 7 years (usually, this is recommended), then you need to use factor 2,83 to multiply the remaining result.
This will give you the calculated estimated goodwill.
You can download a template here that can be used to estimate your goodwill:
What if the goodwill is calculated to zero or even minus?
Regardless of what the calculation shows, you still need to use the actual price for the company that you would get if sold to someone you are not related to.
So try and consider if the estimated goodwill is realistic.
If you do not feel confident with the value, then ask the tax office:
When can you make a “tax-free” conversion?
A “tax-free” conversion goes into effect from the 1st of January in any given year.
You can make the “tax-free” conversion six months back in time.
So it means that you can make the “tax-free” conversion between the 1st of January and the 30th of June each year – that will go into effect from the 1st of January the same year (also back in time).
(This blog was updated last time: 20.1.2023)