How to convert your sole proprietorship to ApS in 2024

How to convert a sole proprietorship to ApS in 2024

You would want to convert your sole proprietorship to ApS for many reasons.

Very often, it relates to liability protection or tax advantages.

Or simply because you want a more professional image.

First, you must ensure you can run your business 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 converting your sole proprietorship to ApS.

Option 1 – A “tax-free” conversion

When the business has significant value, making a “tax-free” conversion often makes good sense.

The reason for this is:

When a sole proprietorship is converted to an ApS, you need to treat it as if the sole proprietorship (machines, equipment, goodwill, liabilities, etc.) were sold to the new ApS.

So, if the sole proprietorship’s value is high – e.g., if you have high revenue and many clients – selling the company to the ApS would yield a profit.

This profit would come from selling the machines and equipment – and also from selling the clients.

We call the value of the clients “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 value of your business – including the goodwill – and issue an audited statement.

Also, the auditor will typically incorporate the ApS.

Once the sole proprietorship is converted to an ApS, you will have a future tax liability calculated from the profit that came from “selling” the business to the ApS, based on the value of the business determined by the auditor.

The fee for the auditor when making a “tax-free” conversion is typically in the range of 20.000-30.000 DKK + VAT, depending on how complex your business is.

Why is it called “tax-free”, then?

A more correct term would have been a “tax postponed conversion” – since you still owe the tax from the conversion to the Danish Tax Agency.

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 a “tax-free” conversion – you get to postpone the tax.

Option 2 – A taxable conversion

When you are in the opposite situation where the business has little value, making a taxable conversion often makes 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 20.000-30.000 DKK + VAT), making a taxable conversion usually makes good sense for a small sole proprietorship.

The value of a sole proprietorship

The value of a business is what someone is willing to pay for it.

However, since we only sometimes have a buyer on hand, we must make some assumptions about the value.

We usually look at the difference between the assets and the liability.

Assets f.ex. consist of

Goodwill;
Improvements to leased premises;
Machines;
Equipment;
Deposits;
Receivables from customers;
Cash and bank deposits;
And more.

The liabilities f.ex. consists of

Supplier debts;
Loans;
VAT debt;
Employee tax debt;
And more.

Most of these have the value you can see in the balance sheet.

If you owe 1.000 EUR to a supplier, the liability value is 1.000 EUR.

You must estimate the current value for things like machines and equipment.

Goodwill is very often valued at zero in the balance.

That is because you did not have any goodwill when you started the sole proprietorship.

So, you have been building up an increased value of your clients’ goodwill over the years, which is not shown in the balance as an asset.

Typically, goodwill is the point of interest when converting to ApS.

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 business?

To calculate the value of your business, we need to calculate the value of your goodwill in addition to the machines, equipment, liabilities, etc.

There is no law on how the value of goodwill should be calculated.

And in general, if a business were sold to someone unrelated to you, that price would have to be respected.

However, when converting a sole proprietorship to an ApS you own, you act as both the seller and the buyer.

Therefore, the price you decide to sell for must be documented somehow.

In general, there are five methods you can use to document the value of your business:

1: Use an existing tradition for valuation in your industry;
2: Use the guidelines made by the Danish Tax Agency to estimate goodwill;
3: Use your way to determine the value of the business;
4: Use an offer from a non-related person that wants to buy your business;
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 the value of your business, 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.

However, not all industries have established traditions for evaluating the value of goodwill.

Option 2: Use the guidelines made by the Danish Tax Agency to estimate goodwill

The Danish Tax Agency has made a set of guidelines for calculating an estimated value of goodwill.

So, you can use the Danish Tax Agency estimate of the goodwill and add that to the other assets and liabilities.

Then, you will also get a calculated value for your business.

We have also created an Excel sheet you can download and use to calculate the goodwill using the Danish Tax Agency guide – please see below.

Option 3: Use your way to determine the value of the business

Of course, this can be a bad idea if your calculations differ from industry norms or the Danish Tax Agency guidelines.

In the worst case, you must pay tax on a value that the Danish Tax Agency later estimated.

To limit the risk, you can request the Danish Tax Agency approve your valuation before converting.

Doing that will take the uncertainty away.

But it will add a few months to the processing time.

You can apply for written approval here with the Danish Tax Agency

Option 4: Use an offer from a non-related person that wants to buy your business

If you have a current offer from a non-related person on hand, you are allowed to use this to determine the value of your business.

Option 5: Use a valuation made by a professional

You can also hire a professional – e.g., a company broker or auditor – to do a valuation.

Calculation of goodwill – using the Danish Tax Agency guideline

The Danish Tax Agency guideline calculates the value of goodwill using the last three years of profit for a 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.

Generally, you need to use the profit calculated from the accounting rules.

If your business 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 2024, then we would look at

1: Profit in 2023 before interest and taxes;
2: Profit in 2022 before interest and taxes;
3: Profit in 2021 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 is the regulated profit for each of the three years.

Now, we need to calculate the average profit of these three regulated profits, with the newest year 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 2023 x 3;
2: Regulated profit in 2022 x 2;
3: Regulated profit in 2021 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 yearly from 2021 to 2022 and 2023, we add 50% from 2021 to 2023.

Then, we deduct a salary for the sole proprietor that is 50% of the remaining result – 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.

This is done by looking at the clients’ lifespan expectancy.

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
1	0,46
2	0,91
3	1,33
4	1,74
5	2,12
6	2,48
7	2,83
8	3,16
9	3,48
10	3,78

If the client’s lifespan is 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 the calculation, you still need to use the actual price for the business you would get if sold to someone you are not related to.

So, try to consider whether the estimated goodwill is realistic.

If you do not feel confident with the value, then ask the Danish Tax Agency:

You can apply for written approval here by the Danish Tax Agency

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 – it will go into effect from the 1st of January the same year (also back in time).

(This blog was updated last time: 13.8.2024)

FAQ