What Happens With Retained Earnings When You Sell Your Company?
When you sell your company, you can say goodbye to the company's retained earnings. Depending on whom you sell to, those retained earnings could become the new owner's retained earnings, or they could essentially disappear. Regardless, you don't get to "take them with you." In fact, it's not really possible to take them with you.
The retained earnings entry on your company's balance sheet represents all the profits that the company has reinvested in itself. Companies can really do only two things with their profits (just another word for "earnings"): distribute them to the owners or reinvest them in the business -- purchasing new equipment, for example, or opening a new location. Profits that you and any co-owners don't take for yourselves are retained by the company. Thus, they're "retained" earnings.
In many people's minds, "profit" is synonymous with "extra cash." And indeed, that definition usually applies in personal finance. But businesses don't retain profits just so they can watch cash pile up. They do it so they can use the money for such things as buying inventory and investing in buildings, equipment and other long-lived assets. The retained earnings line is simply an accounting entry that totals up all the profits your company has reinvested over the years. In all likelihood, some of those earnings do currently exist as cash, but others are in the form of company assets, both tangible (buildings, equipment, inventory) and intangible (customer loyalty, your good brand name).
When you sell your company, what happens to retained earnings depends on who you sell it to. If you simply sell the company to a person who will maintain the business as a going concern, then nothing happens. Retained earnings is part of the owner's equity section of the balance sheet. When you owned the company, that section represented your equity in the company. The company has a new owner, and that section now represents that person's equity. Your retained earnings simply become the buyer's retained earnings.
Things are different when you sell the business to another company that will absorb it entirely or treat it as a subsidiary. Such a buyer will take the items from your balance sheet and add them to its own, a process called consolidation. Your company's assets become assets of the buyer. Your company's liabilities also become the buyer's liabilities. (So if your company owed $10,000 to the bank, now the buyer owes $10,000 to the bank.) Owner's equity, however, disappears with the old owner -- and that includes retained earnings.
Say your company has $100,000 in assets, $60,000 in liabilities and $40,000 worth of owners' equity. (Assets minus liabilities always equals equity.) Now you sell out to another firm for, say, $75,000. First of all, the buyer's assets decrease by $75,000 (what it paid for your company). The buyer then adds your $100,000 in assets and $60,000 in liabilities to its own. Because it paid $35,000 more than the $40,000 equity value, the company reports the extra amount as an intangible asset called goodwill. The buyer's balance sheet shows a net increase of $60,000 in assets ($135,000 minus $75,000) and an increase of $60,000 in liabilities. The new assets minus the new liabilities equals zero. Owners' equity does not transfer to the consolidated balance sheet.