operational, transitional and exit strategies for closely- held and entrepreneurial business owners...
TRANSCRIPT
Operational, Transitional and Exit Strategies for Closely-
Held and Entrepreneurial Business Owners
Robert Gabrielski, Esq., Moderator
1/17/2007
Laize Faire Software
Organized as a C-Corporation Choose right entity for transition planning
Tax planning Management structure Ownership structure Possibility of providing incentive arrangements
Laize Faire may not have been organized as a C-corp today
Choosing an Entity
Corporation Centralized management Taxation on entity and shareholder level
S-Corporation Tax election as shareholder pass-through Subject to certain limitations
No more than 100 individual shareholders May only have common stock
Choosing an Entity – con’t
Limited Liability Company Pass-through taxation No personal liability for members Flexibility in structuring management; ownership
rights and distribution rights Partnership
Pass through taxation Personal liability for partners
Negotiating Exit Strategies (Cashing out)
Plan for exits in buy-sell agreement Provide liquidity of ownership interest Exits may be restricted but cannot completely
prohibit transfer Issues to consider in planning transition
Voluntary transfer restrictions Address and plan for involuntary transfers Structure different classes of ownership rights
(depends on type of entity)
Restrictions on Voluntary Exits
Right of First Refusal Must offer to other owners and/or company first on same
terms and conditions
Put/Call Rights Shareholder’s right to require other shareholders and/or
company to buy interest (Put) Company’s right to purchase interest (Call)
Tag/Drag Along Rights Right (Tag-Along) or requirement (Drag-Along) to
participation in sale of assets or ownership interest
Address Involuntary Exits
Death Disability Retirement Termination for Cause Lien placed on interest (i.e., bankruptcy) Valuation; terms of payment - may depend on
circumstance
Structuring Ownership Rights
Vehicle to facilitate transition Can have varied rights (i.e., voting or non) Can be equity, debt and/or combination Can be structured to:
maintain control obtain preferred return offer incentive compensation provide liquidation or any other preference
Executive Compensation
Planning Considerations
Attract new employees Retain existing “key employees” Provide employees with a greater sense of
involvement in the financial performance of
the company
Executive Compensation
Additional Considerations Succession planning issues Increased productivity/profitability
Financial targets Cash flow planning issues
Employment contracts – “golden handcuffs”
Executive Compensation - Equity
Outright grants of stock shares/LLC units Provides the employee with an ownership interest
in the company Permits the employee to share in the financial
success of the company Can utilize different classes of stock Shareholder dilution/transferability issues Current income taxation
Executive Compensation – Equity
Restricted Shares/LLC Units Addresses transferability issues May result in deferred income tax recognition by
the recipient Requires a written agreement between the
company and the employeeShareholders Agreement
Liquidity issuesBuy-back, claw back, employment termination
Executive Compensation – “Phantom Equity”
A bookkeeping entry that provides an “equity like” interest Value may be determined based upon an
underlying equity interest in the companyStock Appreciation Rights (“SARs”)
Can provide for dividends/distributions Does not provide the plan participant with an
ownership interest in the company Liquidity issues
Executive Compensation – Deferred Compensation
Current promise to pay compensation in the future Flexible structure – nonqualified arrangement Company stock/equity can be an “investment”
option Easily tied to company financial performance Administrative burdens/liquidity issues Code Section 409A Funding options
Executive Compensation – Other Equity Arrangements
Stock Options Non-qualified and incentive stock options
Qualified Defined Contribution Retirement Plans Investment options Matching contributions
Employee Stock Ownership Plans (“ESOPs”) Employee Stock Purchase Plans (“ESPPs”)
Executive Compensation - Planning Considerations
Who should benefit? What type of benefit should a participant
receive? What costs are involved to the sponsoring
company? Incentive compensation goals vs. succession
planning goals Income tax issues Cash flow maintenance
What taxes are we trying to minimize?
Income tax Ongoing operations Sale of business
Estate / Gift tax Sales and Use Import / Export duties ALL OF THEM
Three Rules for Making Effective Business Decisions
Decisions should make sense short-term Decisions should position the business for
the best chance of long-term success Decisions should be tax-efficient
(See the three rules of tax planning)
What do buyers want?
Lowest possible selling price Maximize current tax deductions*
* Public companies are generally more interested in maximizing EPS than minimizing taxes
Allocate to: Sellers Buyers
Stock (corp.) Capital gains No tax write-off
P-ship interest (includes LLC)
Generally capital gains
Step up assets
Asset Sale Generally capital gains (*C-Corp trap)
Step up assets
Compensation Ordinary plus FICA or SE
Deductible
Worst Case
C-Corp Asset SaleAssume selling price $92,000,000C-Corp tax (40%) – 36,800,000Proceeds to seller $ 55,200,000Individual tax (24%) – 13,248,000Net after tax to seller $ 41,952,000
Tax cost ≈ 55%
New Businesses
Generally should be Partnerships for tax reasons Corporate protection for legal reasons
“LLC”
With a business valuation, there is less reliable information available on the sales of other businesses
Case Study One
Cardboard box Every Monday the box generates $100 (except for
two weeks of summer) The box has followed this pattern for the last 50
years The box is expected to continue this path for the
next 50 years
Case Study Two
Cardboard box Every Monday the box requires a deposit of $100
(no summer vacation) The box has followed this pattern for the last three
years The expectation is that the box now contains the
next big thing in the industry
Discounts for Lack of Control and Lack of Marketability
If Boris is to get a 10% interest Subject to numerous restrictions
Transferability Voting Rights Etc.
Discounts for Lack of Control and Lack of Marketability
Then the value of the 10% is not $9.2 million (10% of $92 million)
It is worth less than $9.2 million
Buy-Sell Agreement
Who are the potential buyers? If Joe sells company to Boris? After Joe dies who buys the company ?
10 yr Installment note $85,000,000 @ 6%
annual payment $11,000,000
Life Insurance policy for $85,000,000
annual premium $2,250,000
Protecting Your Company’s Assets Through Confidential,
Non-Compete and Invention Agreements
Patrick T. Collins, Esq.
The Basics
What is an employer’s protectable interest and how is that defined? Customer relationships Confidential business information Trade Secrets
To What Specific Information Have Courts Granted Protection?
Scientific data, chemical processes, manufacturing methods
Business information-marketing plans, pricing policies, financial information
Computer programs/data compilation Client lists, needs, preferences and/or
contacts
“Trade Secret” Status Will Not Be Provided To
The general skills/experience an employee acquires over time
Specialized skills, experience, contacts which an employee had prior to working for an employer
Factors In Determining Whether Information Is Proprietary1) The extent to which the information is known
outside of the owner’s business;2) The extent to which it is known by employees and
others involved in the owner’s business;3) The extent of measures taken by the owner to
guard the secrecy of the information;4) The value of the information to the owner and his
competitors;5) The amount of effort or money expended by the
owner in developing the information;6) The ease or difficulty with which the information
could be properly acquired or duplicated by others.
Missing Information
When did Boris sign the Agreement? Where was it signed? How long are the restrictions? What are the restrictions?
Geographic Customer Based
Blue Pencil States?
“Work-For-Hire” AgreementsThe General Rule:
Inventions belong to the inventor-the person who conceived, developed and perfected it
Exceptions:
Employees hired to invent Specific contractual arrangements
Employment for Purpose of Inventing
Definition: Employee who is hired for purpose of inventing and who succeeds in accomplishing task during employment must assign to employer all rights to the invention.
Invention must be developed during period of employment Express agreement on scope of employment should be
present Place where invention created generally not determinative
Shop Rights
Invention made by employee during working hours using employer’s materials and equipment provides employer with irrevocable but non-exclusive right to use of invention.
Employer does not obtain a shop right where idea was originated and fully developed by employee at home and not using material or labor of employer.
Shop right is personal and exclusive to employer. Cannot be assigned or transferred by employer to third party.
Written Agreements
Consideration (Employment/Continued Employment)
Permissible Scope- Generally Courts will not enforce agreements that
unreasonably obligate an employee to transfer ownership rights in each and every instance.
Typical Contract Language
The employee agrees to assign all inventions except those for which no equipment, supplies, facilities or trade secrets of employer was used and which was developed on employee’s own time unless (i) invention relates to business of employer or (ii) invention results from work performed for employer.
What Happens If Boris Leaves?
Why/How did Boris leave? Holdover invention agreement
- Generally must be limited to a reasonable time and to subject matter which employee worked on or had knowledge of during employment
The Corporate Opportunity Doctrine
1. A corporate opportunity is presented to an employee;
2. The company can undertake it financially;
3. It falls within the company’s normal business;
4. The company has an interest/expectancy in such opportunities.