Tax and Legal, small company buyout

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J3774
Posts: 7
Joined: Wed Mar 24, 2021 8:26 pm

Tax and Legal, small company buyout

Post by J3774 »

I am a minority shareholder in a small tech company, S-corp. It is highly likely we are going to be bought by a larger company within the next month or two.
The sale price is still TBD, but I expect my share of the proceeds to be about $900K. This will be nearly 100% capital gains, as the company started from scratch with ~ 0 basis. I will be asked to stay some number of years (likely 2). There will be a non-compete clause.
I'm ok with all that so far.
My question is: What legal issues or payment mechanics should I be aware of before the details start? I haven't done this before. My spouse is an attorney and has identified an attorney (not with the curent company) in town who can help. However, I haven't talked to that person yet and I am interested in the collective wisdom I see on this site. Our town is not that big, and the company already has the attorney my wife thought best.

Background
Age 62, spouse 61.
Assets with spouse:
$2.5 M, retirement accounts.
$2.5 M, taxable accounts.
No debts
Yearly income :$400K joint salary + $100K dividends from the company (which will go away)
Can I ask for payments to be spread out? I don't need the money today and am concerned about the tax hit. I know there are potential capital gains tax changes for 2021. I'd like to not go over the $1M mark, since I read that CG tax may be increased to 40% in that case.
What other things (the unknown unknowns) should I be concerned about? I am a minority shareholder so I may not have much influence, but I will have no influence if I am not aware.

Thanks for your time.
Jack
J3774
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David Jay
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Location: Michigan

Re: Tax and Legal, small company buyout

Post by David Jay »

Minority stockholders really don't get much say in a buyout. You are mostly "along for the ride".

If they are requiring that you stay for 2 years as a condition of purchase, I would want to discuss some flexibility (perhaps a stock swap with the acquiring company or something else so you don't have to take the entire $900,000 capital gain in a single year).
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
J295
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Joined: Sun Jan 01, 2012 10:40 pm

Re: Tax and Legal, small company buyout

Post by J295 »

If you decide to let the tax tail wag the dog and spread out the payment understand that you will be a creditor with the accompanying risks.
HootingSloth
Posts: 1050
Joined: Mon Jan 28, 2019 2:38 pm

Re: Tax and Legal, small company buyout

Post by HootingSloth »

Some things you might consider asking your attorney about (or even reading about online if you are so inclined) include the consequences of an asset or stock sale, the significance of a section 338(h)(10) election, the built-in gains tax under section 1374, and the importance of avoiding (or addressing) an inadvertent termination of S corporation status. Acquisitions of S corporations with minority owners can sometimes be a bit tricky, depending on how things go. Unfortunately, when a company is relatively small the issues are no simpler but the legal fees can be proportionately more burdensome. Good luck!
Global Market Portfolio + modest tilt towards volatility (80/20->60/40 as approach FI) + modest tilt away from exchange rate risk (80% global+20% U.S. stocks; currency-hedge bonds) + tax optimization
RubyTuesday
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Joined: Fri Oct 19, 2012 11:24 am

Re: Tax and Legal, small company buyout

Post by RubyTuesday »

J3774 wrote: Sun Jun 20, 2021 12:30 pm I am a minority shareholder in a small tech company, S-corp. It is highly likely we are going to be bought by a larger company within the next month or two.
The sale price is still TBD, but I expect my share of the proceeds to be about $900K. This will be nearly 100% capital gains, as the company started from scratch with ~ 0 basis. I will be asked to stay some number of years (likely 2). There will be a non-compete clause.
I'm ok with all that so far.
My question is: What legal issues or payment mechanics should I be aware of before the details start? I haven't done this before. My spouse is an attorney and has identified an attorney (not with the curent company) in town who can help. However, I haven't talked to that person yet and I am interested in the collective wisdom I see on this site. Our town is not that big, and the company already has the attorney my wife thought best.

Background
Age 62, spouse 61.
Assets with spouse:
$2.5 M, retirement accounts.
$2.5 M, taxable accounts.
No debts
Yearly income :$400K joint salary + $100K dividends from the company (which will go away)
Can I ask for payments to be spread out? I don't need the money today and am concerned about the tax hit. I know there are potential capital gains tax changes for 2021. I'd like to not go over the $1M mark, since I read that CG tax may be increased to 40% in that case.
What other things (the unknown unknowns) should I be concerned about? I am a minority shareholder so I may not have much influence, but I will have no influence if I am not aware.

Thanks for your time.
Jack
J3774
In addition to talking with attorney, consult knowledgeable CPA on tax issues. There were some things we did related to “hot assets” that helped with taxes and didn’t cost acquirer anything. Many attorneys may not be knowledgeable on tax consequences of deal structure.
“Doing nothing is better than being busy doing nothing.” – Lao Tzu
CloseEnough
Posts: 1290
Joined: Sun Feb 14, 2021 7:34 am

Re: Tax and Legal, small company buyout

Post by CloseEnough »

In my experience 2 years is a long time to ask a minority shareholder to stay and to tie payout to. I’d consider if negotiating a shorter time is possible, and discuss with your lawyer whether in your circumstances it’s reasonable.
SubPar
Posts: 454
Joined: Mon Apr 27, 2020 11:48 am

Re: Tax and Legal, small company buyout

Post by SubPar »

Generally, I've seen longer-term payouts being structured around some element of contingent consideration (i.e., an earn out tied to some financial metric over an extended period), which adds another element of risk/uncertainty.

A good CPA and legal firm with M&A experience is necessary, as already stated. Congrats, best of luck!
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nss20
Posts: 57
Joined: Wed Jan 01, 2020 12:36 pm

Re: Tax and Legal, small company buyout

Post by nss20 »

The tax implications are dependent on the deal structure.

If it is an asset purchase then your company remains and the money will first flow into the company before being distributed to the stockholders. In that case, it might be treated as income instead of capital gains. On the other hand, if your company is bought (with assets and liabilities) then it's all likely to be capital gain. Furthermore, it may even be possible to set up the deal structure so that you get the acquirer's stock and there may not be any capital gains until you sell the acquirer's stock.

A typical deal structure can lead to payouts at different times. First is the immediate payment. The second part may be an escrow for say 12 months, to cover liabilities against warranties and representations that sellers make, and finally, there may also be 'earn-outs. The tax treatment of the immediate payment and the escrow could be the same while the earn-out may be treated differently depending on how it is structured.

Typically buyers focus on getting their money as soon as possible and in ensuring that earn-outs are within their control. A clean deal is much better than conditions that delay or cloud the full payment. In my opinion, all of this comes ahead of tax considerations though tax considerations are important as well. Also, don't forget to ask for stock options in the acquirer's stock as part of your new employment contract, especially if you feel that the acquirer's stock will be worth more in future.

Caveat: I have no expertise in law, accounting, or M&As.
jackets320
Posts: 45
Joined: Mon Oct 08, 2018 9:32 am

Re: Tax and Legal, small company buyout

Post by jackets320 »

Be sure to confirm what your company is selling. If it is stock sale then capital gain rates apply. If selling the assets of the company then there could be a lot of ordinary income, depreciation recapture, etc that regular tax rates apply. It can make a Hugh difference in your tax bill.
jackets320
Posts: 45
Joined: Mon Oct 08, 2018 9:32 am

Re: Tax and Legal, small company buyout

Post by jackets320 »

Be sure to confirm what your company is selling. If it is stock sale then capital gain rates apply. If selling the assets of the company then there could be a lot of ordinary income, depreciation recapture, etc that regular tax rates apply. It can make a Hugh difference in your tax bill.
Flashes1
Posts: 1431
Joined: Wed May 07, 2008 7:43 am

Re: Tax and Legal, small company buyout

Post by Flashes1 »

I'm sensing you need expert legal and tax accounting advise which means you likely need to approach firms in your region's business hub. Firms with 100+ attorneys you see in every business hub like Milwaukee, Cleveland, Pittsburgh, Charlotte, Tampa, etc.

This kind of firm has both legal and tax experts and both will communicate with each other to represent your needs.
Topic Author
J3774
Posts: 7
Joined: Wed Mar 24, 2021 8:26 pm

Re: Tax and Legal, small company buyout

Post by J3774 »

Thank you to all who responded. Some of the answers were helpful in making me aware of things to ask about and read about.

To address some of the raised issues:
1. Acquiring company is owned by private equity, so I think a stock trade is not feasible.
2. Our company has good representation for tax and legal issues, but I was looking for what I, as an individual, should be thinking about. (even though I'm a minority stockholder, so I may be, as one person put it, "along for the ride..."
3. Yes, two year lockup seems long, but this is highly technical area with a lot of hardware process IP. I understand their point of view so it will be discussed.

Best regards,
Jack
Meeshigan
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Joined: Fri Jul 17, 2020 12:53 pm

Re: Tax and Legal, small company buyout

Post by Meeshigan »

You should ask your company to pay for your lawyer or some part of it if they haven't offered that already. The company's M&A lawyer doesn't/can't represent you. Giving you separate counsel gives the majority shareholders some cover on fiduciary type claims that you might otherwise have against them.
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David Jay
Posts: 14586
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: Tax and Legal, small company buyout

Post by David Jay »

J3774 wrote: Thu Jun 24, 2021 9:43 pm3. Yes, two year lockup seems long, but this is highly technical area with a lot of hardware process IP. I understand their point of view so it will be discussed.
The question is: What happens if you were to say "I'm leaving the company today"? Would that kill the purchase?

If so, you have some real leverage to see to it that your interests are protected. I'm not suggesting being a jerk, but it is reasonable to ask for accommodation.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
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