Understanding Securities Law
The business professional's guide to securities laws
 

Many owners of successful private businesses today are looking to cash out their equity in the business but really do not want to sell the entire business and retire right away.

 

Business owners have also read that becoming a public company may significantly increase their net worth. Sellers of private companies generally sell their business at an average of 3 to 5 times net after-tax earnings. Further, many times the seller must take back paper to finance the purchase. And have no further involvement in the business. Stock of a public companies may sell for 10 to 20 times earnings. For example, assume your company has annual after tax earnings of $5,000,000. At 5 times earnings, your company’s value would be $25,000,000. But finding an all cash buyer at this amount could be quite difficult. And capital gains taxes would apply. As a public company, if your stock trades at 15 times earnings, your company’s value would be $75,000,000.

 

One way to become a public company to accomplish this objective is an Initial Public Offering, or IPO. However, there are several problems with an IPO:

1. The IPO market is essentially closed right now.
2. IPO’s are expensive – generally over $1,000,000, sometimes much more.
3. Not all IPO’s are successful. Underwriters can back out at the last minute, leaving a business owner with significant expenses but no results.
4. An IPO does not generate any significant cash for the business owner. Generally underwriters require that almost all of the proceeds be invested in the business, not paid to owners.
5. Owners can sell their stock under Rule 144. However, the amounts are limited. And this selling may significantly depress a company’s stock price.

In this section of the site, you will learn about an alternative: A combination of Going Public through a Self-Underwriting and an Employee Stock Ownership Program. In addition to increasing the value of a business owner’s equity, this combined program allows a business owner to: 

• Continue to own and control the business – In order to obtain the tax deferral benefits under this structure, the business owners only need to sell 30% of the equity in their business to the ESOP.

• The company can borrow the money to cash out the equity and deduct both principal and interest payments – The law concerning ESOP’s provides that your company can borrow the money to fund the ESOP and deduct both principal and interest payments.

• That’s right: There is one type of loan that allows your business to deduct not only interest but also principal payments.

• There is a potential to defer all federal taxes on the sale of the equity – If the proceeds of the ESOP buy-out are rolled over into a qualified investment, all federal taxes are deferred.

• The business can provide an employee incentive program – An ESOP is an employee incentive program. Your employees become stakeholders in the business, which may result in increased productivity and profitability. And as a public company, ESOP valuation issues are avoided and provide the ESOP with a liquid market for the stock it owns when it is required to make redemptions under ESOP rules.

• Another plus: This allows a business to reward its existing employees it wants to retain in these difficult economic times.