Are you an NCEO member? Learn more or sign up now.

Home » Publications »

Selling a Company Directly to Employees

by Nathan Bennett, Robert Bye, Robert Reilly, and Corey Rosen

$15.00 for NCEO members; $25.00 for nonmembers

A 20% quantity discount will be applied if you are a member (or join now) and order 10 or more of this publication. If you need to order more than the maximum number in the drop-down list below, change the quantity once you have added it to your shopping cart.

This ebook may not be resold or given away to others. If you would like to share this book with another person, please purchase an additional copy for each recipient. For example, if you want a copy for yourself and two colleagues, choose the quantity 3, add it to your cart, and check out. You will then download one copy that you can also provide to your two colleagues. Thank you for respecting our rights as an independent publisher.

Quantity:

NCEO members who supply their members area username and password during checkout can download digital publications like this one immediately after submitting an online order. Others will immediately receive a download link that will become live within one business day.

For many business owners, an employee stock ownership plan (ESOP) is the best solution for business transition. But for others, whether for issues of size, economics, or personal preference, selling directly to one or more employees is a better option. This issue brief provides a detailed look at how this can be done, exploring alternative structures, financing arrangements, how to use insurance in buyout agreements, legal issues, and tax concerns. Also included is a comprehensive explanation of how businesses are valued. Finally, the brief compares an ESOP sale to a sale directly to employees.

Publication Details

Format: PDF, 64 pages
Dimensions: 8.5 x 11 inches
Edition: 1st (July 2011)
Status: Available for electronic delivery

Usage Rights for NCEO Digital Publications

When you download an NCEO digital publication that you purchase or subscribe to (or that someone purchases or sponsors for you), you may copy it to any computer or other electronic device you personally use, and you may print it for your own use. However, you may not share it with others unless you purchase a license to do so or buy a copy for each person.

Contents

Introduction
Selling a Closely Held Company Directly to Insiders
Valuation Considerations in a Sale to Employees
Using Buy-Sell Agreements in Employee Buyouts
The Manager's Dilemma: Buy Out Your Company or Do an ESOP?

Excerpts

From "Selling a Closely Held Company Directly to Insiders"

Grantor trusts of the type described here and in the next section are most often used for transfers to children or other family members, although they theoretically could be used for employees. An intentionally defective grantor trust (IDGT) is an irrevocable trust that the grantor purposely creates to be "defective" for income tax purposes, but "effective" for transfer tax purposes. If properly designed, the IRS treats the grantor as the owner of the trust's assets only for income tax purposes (a so-called "grantor" trust). After the IDGT is established and a small gift (i.e., seed money) is made to the trust, the grantor sells income-producing assets (i.e., stock) to the trust in exchange for the trust's installment note. The sales price may incorporate valuation discounts.

In the typical sale to an IDIT no down payment is made, the IDIT pays the grantor annual interest only at the IRS Applicable Federal Rate for the month of the sale, and there is a balloon payment at the end of nine or more years. Because the sale is between the grantor and his or her grantor trust, the IRS does not recognize any gain or loss on the sale. Under Revenue Ruling 85-13, transactions between a grantor and his or her grantor trust are disregarded for income tax purposes. If the assets in the IDGT appreciate greater than the IRS Applicable Federal Rate, such excess value is removed from the grantor's estate. Additional transfer tax savings occur because the grantor is not separately taxed on the interest payments but instead is responsible for paying all of the IDGT's income taxes.

The expectation is that the growth of the assets in the trust outpaces the income needed to pay interest and someday deliver on the balloon payment. If valuation discounts are applied (and they almost always are) this is easier to achieve. If the grantor dies before the balloon payment is made, the value of the balloon payment is includable in his or her gross estate, but the growth in the asset from the date of transfer to the date of death is still outside of the estate.

Note that the very benefit that makes this technique attractive (defective for tax purposes, causing no capital gain upon sale) can also be its biggest liability. All of the income taxes owed by the IDGT are the responsibility of the grantor, not the trust. As a result, it is important to make arrangements for that liability. Practitioners of this technique advise that grantor trusts are not for those who cannot afford them.

The ability to transact large amounts of value without recognizing capital gain and the flexibility of payment options presented by the IDGT has made this a very popular technique among practitioners. However, they involve more than a basic level of complexity and a fair amount of analysis and arithmetic to ensure they are a good fit for a given situation.