Business owners and entrepreneurs typically operate in a very fast paced environment and, as a result, can be unprepared for a transaction when the opportunity arises. If they face a potential transaction to raise capital, sell their business or acquire another company, they may not have had time to consider options to restructure their existing company to simplify or streamline the transaction. A few options should be considered.
Consider a Reorganization
Many companies operate as S Corporations. While this structure provides noted benefits, there are also limitations related to who can be an owner of an S Corporation. For example, S Corporations limit owners to US individuals and certain trusts; thus, a C Corporation, partnership, or foreign individual cannot be an owner. As a result, if a business owner is considering selling a portion of his ownership in a company as part of a succession plan or is considering admitting new owners to raise growth capital, an S Corporation structure can be a challenge.
A common work around is to undertake an F Reorganization under Internal Revenue Code (IRC) Section 368. With this structure, the operating company becomes a subsidiary of a new S Corporation and allows the owners to continue owning their portion of the operating entity through an S Corporation, while allowing new investors to invest directly into the subsidiary.
Other benefits of a reorganization include the ability to sell all or a portion of a company more easily if it has:
- non-transferable contracts
- vendor numbers tied to the existing entity’s tax id number, or
- a large quantity of contracts or numerous assets that would require title transfers
Alternatively, if the current entity is operating as a partnership, it may also be beneficial to create a Limited Liability Company (LLC) to function as a holding company to realize similar benefits.
Consider Management Equity Plans
As a company is growing, key employees will be brought on board to take on management roles, help grow the company, and add to the value. It is critical for a business to retain key individuals, especially when it is time to sell or pursue a transaction to obtain growth capital. One retention option is to implement a management equity plan. These plans vary widely and can include phantom ownership, actual ownership, and ownership that vests over time or based on performance. Key to each option is the benefit to key employees who have helped to grow and expand the business.
Consider Family Wealth Transfers
Often, the best time to gift a portion of a company to children or other family members is when the value is low. Entrepreneurs are often hesitant to give up control or make a transfer to family members until they are sure that the company is going to thrive. Thus, it is important to monitor overall company value and consider timing gifts to occur prior to a transaction. When an owner decides to make a gift, the company must be valued, and the value may be set at a higher number if it is established by reference to a letter of intent, or a consummated transaction; hence making transfers prior to transactions beneficial.
Contact Us
If your company is growing, or you see a potential transaction in your future, Clayton & McKervey can review how these strategies may help you. For additional information, call us at 248.208.8860 or click here to contact us. We look forward to speaking with you soon.
