A Corporate Case Study
The client, in this case, was a professional service consulting firm with operations in the United States, England, and Sweden. Over the years, LGA provided audited financial statements for both the Company and its 401(k) Plan, as well as tax planning and compliance services to this owner-managed business. The company grew and prospered thanks to the efforts of its dedicated owners and several key employees. The owners of this closely held company were looking for an exit strategy, but they also wanted to make sure their key employees would be rewarded for their dedicated service. A direct stock sale to the key employees was contemplated, but the owners felt that this option was riskier to them and might delay their exit from the Company. Word spread around the industry that the Company was looking for an acquisition or merger partner and soon the Company was being courted by a major player in their industry. What would be the best overall, tax efficient strategy to accomplish the sale?
Over the years the Company granted thousands of stock options to key employees who had directly built the relationships with their clients who led to the growth and profitability of the Company. With a sale on the horizon, it was assumed that the sale options were limited. The employees would exercise their shares, diluting the owners’ shares, the Company assets would be sold, the key employees would recognize additional compensation taxed at ordinary income tax rates and the owners would get long-term capital gain treatment. Still, we looked for better alternatives. We reviewed all the standard sale options like asset sale vs. stock sale and the various tax consequences to the Company, the owner/shareholders, and the key employees. LGA, the Company’s Trusted Advisor for many years, knew the owners and key employees and as a result of this relationship and our experience, we developed a tax concept that might convert ordinary income into capital gain for the employees. We suggested that part of the sales price that would otherwise go to the key employees as compensation would be characterized as the sale of their personal goodwill. The premise is that a significant portion of the Company’s value is directly attributable to the key employees’ personal connections and relationships with the Company’s clients. We worked with the Company’s counsel and the buyer’s representatives to incorporate this approach in the deal. This significantly enhanced the value of the sale to the key employees without negatively impacting the tax results for the owners. We were able to change the character of a significant portion of the selling price to capital gain which was then taxed at lower capital gains rates.
The preceding is a very simplified version of a very complicated transaction. The structure of the deal worked out for all involved. The key employees pocketed more after-tax sales proceeds, and the owners were extremely pleased that their valued employees benefited at a microscopic cost to them.