As a small business owner, you make lots of decisions every day, from what to sell to which companies to do business with. The concept of arm’s length comes into play when you make transactions with outside parties. Arm’s length refers to a transaction or sale between your company and another company or person who isn’t closely related to you or your company. In other words, there’s a figurative distance between the two people in the transaction.
Why should you care about arm’s length? In certain types of transactions, a close personal relationship between the two involved parties can change the nature of a transaction. An arm’s length transaction between two unrelated parties is very different from a transaction between two family members . Take real estate, for example. If you buy a commercial property from a family member, it might affect the selling price. Your sibling might cut you a deal on the property, which lowers the price more than normal. When two unrelated parties enter into a transaction, the buyer usually wants the best deal possible while the seller wants to sell for as high as possible.
People outside of your company usually want to know your business acts at arm’s length for major transactions for a few reasons. It shows you enter into agreements without being forced into the deal. You’re acting in your own self-interest without being under duress, and you have the best interests of the company in mind. Letting others know you operate under this concept shows your business isn’t colluding with any other person or business. External parties, including creditors, tax authorities, and auditors, want to know you’re operating at arm’s length. Banks need to make sure you’re operating your company in their best interests, taxing authorities track arm’s length transactions to make sure transferred or sold goods get taxed at the appropriate value, and auditors assess your company to make sure your financial information is valid and the internal controls you have in place are working. This includes correctly accounting for dollar amounts of transactions.
Using the arm’s length principle when making major transactions for your business takes the doubt out of the deal. It shows you run your business based on fair business practices. Keep your books accurate and up-to-date automatically. Change the way you manage your finances now.