Yes, You Can Share Equity and Stay Private: Part Two

Last week, guest author Corey Rosen of the NCEO started a two-part series on how companies can share equity and stay private. This week, he concludes the series.

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Yes, You Can Share Equity and Stay Private: Part Two

By Corey Rosen, National Center for Employee Ownership

In Part One of this article, we looked at general issues for staying private, including plan design and redemptions. Below are four more liquidity options.

Sales to Employees

Employees can buy shares from sellers. The purchase is with after-tax dollars; the proceeds are taxed as a capital gain. Some companies pay employees a bonus to use to buy the shares or loan the money at a reasonable rate, which right now could be very low without incurring a tax problem. It is also possible to set up an internal stock market. The details are beyond the scope of this article. Suffice it to say here that the SEC has made it possible to do this is a way that avoids most significant regulatory burdens.

Outside Investors

We have seen a growing trend in recent years for investors in private companies, whether angel investors or private equity firms, to be willing to invest in closely held companied with the intention of selling to another investor group in 5-7 years instead of forcing a sale to another company. This lets the company stay private, but be aware that these investors may want some level of control even for a minority interest, preferred stock, and/or a relatively high rate of return on their money.

Secondary Markets

If your company is a high-flyer with real prospects to go public at some point, there are now secondary markets such as NASDAQ's SecondMarket and SharesPost,that allow investors to buy equity (usually equity held by employees in the form of options or restricted shares). These rights are then traded on the market until a liquidity event. Only the most promising companies can do this, however.

ESOPs

Employee Stock Ownership Plans (ESOPs) are highly tax-favored ways for companies to redeem their own shares by setting up an employee benefit trust similar to profit sharing or 401(k) trusts that are designed to hold company stock. Companies can use pretax money to redeem the shares through the ESOP, which then allocates them to employees. All full-time employees with a year or more of service are included and allocations are based on relative pay or a more level formula. Sellers can defer capital gains tax on the sale, and S corporation ESOPs can reduce their tax obligation by the percentage of shares the ESOP owns.

These issues are explored in detail in The National Center for Employee Ownership’s Staying Private: Liquidity Options for Entrepreneurial Companies.

Corey Rosen, Ph.D., is the cofounder and senior staff member of the NCEO. He co-authored, along with John Case and Martin Staubus, Equity: Why Employee Ownership Is Good for Business (Harvard Business School Press, May 2005). Over the years, he has written, edited, or contributed to dozens of books, articles and research papers on employee ownership. He is generally regarded as the leading expert on employee ownership in the world.