27 Nov Piecemeal Stock Sale: A Business Redemption
One diversification strategy to take some risk and money off the table and out of the business is to perform a piecemeal stock sale. In this instance, a business owner is converting non-liquid stock within the business into either cash or interest-bearing debt not tied directly to the company itself. When a stock sale to a party other than the business is performed, it generates a single taxable event that is taxed at the capital gains rate as a recognized gain on sale. This helps to ensure any gain in the proceeds of the business are paid out over time and not in a single lump sum.
Who will you sell to?
Who is going to purchase stock in a privately-held business owned and operated by a small, select group of people? Here are some fairly popular candidates:
- Key internal management. Some employees may want to tie more of the gain-sharing and pain-sharing they’re experiencing on a regular basis to the work they provide for the enterprise. This can help to light the fire under some employees as dividends now hit their personal bottom-lines. You have to be careful not to let every Peter, Paul and Mary in the company in on such a deal, however. Giving voting and ownership rights to everyone is not always a great idea. Individual employees investing in the company at this point should also feel they are fully diversified when the piecemeal sale of stock is made.
- Other current and/or existing shareholders. Again, existing shareholder’s should only reinvest if they are willing to take on more risk AND feel they are diversified enough to remain comfortable in putting more cash in the ring.
- New “golfer” shareholders. These could include anyone wanting a passive investment in a private and profitable enterprise.
A piecemeal stock sale of your business is also referred to as a redemption. It generally triggers a single taxable event, but the proceeds are generally treated as a taxable dividend from the business. In some cases, the piecemeal sale can be treated as a non-dividend producing exchange only if it meets the “substantially disproportionate” standard of Section 302(b)(2) or the “not essentially equivalent to a dividend” in Section 302(B)(1). If the dividend rate is equal to the long-term capital gains rate (which is currently at the glorious level of 15%) the only difference would be the tax-free recovery between the dividend tax and the exchange tax. In many cases, this will turn up as negligible, especially if the shareholder has a low stock basis.
Depending on the shifts in the preferential dividend and capital gains rates, there can be wildly different strategies on how to tackle the nitty-gritty of a piecemeal stock sale or business redemption. It is best to talk to a knowledgeable Phoenix M&A advisor to better understand this and other issues in the piecemeal sale of your business.