Planning Ideas Before Taking Your Company Public or Merging with Another Company


After Apple Computer founder Steve Jobs passed away last October, many people reminisced about how this remarkable company was started in Steve’s garage, 35 years ago on April 1, 1976. Steve and his co-founder, Steve Wozniak incorporated Apple the next year and just 3 years later, Apple Computer went public. Like them, millions of American entrepreneurs share the same dream, to take their start-ups and go from “Kool-Aid” stand to household brand. 

If you are among the rare and fortunate few who are actually starting the process to take your company public, or merging with another company, here are some planning ideas, including some ways to structure your company’s ownership now to maximize your family estate and charitable gift planning choices.

Restrictions on Cashing Out or Transferring New Company Stock

Let’s assume that you are an entrepreneur who owns regular “C” corporation stock in a company (meaning it is not “S” stock), or who owns units in an LLC, or an interest in a partnership. (Going forward, we will just refer to all these types of ownership as “stock.”) If your company were to go public or merge with another company, you would encounter three possible restrictions on your stock, which would prevent you from freely transferring your stock in the future: (1) SEC rules, (2) Federal tax restrictions, and (3) contractual or “lock-up” restrictions. 

First, we will consider the SEC issues. The general rule is that all securities must be registered with the SEC, unless there is an exemption from registration. If an individual creates a start-up, typically there is an exemption from registration for the individuals who are owners and operators of the business. These shares of stock, however, are “restricted securities” or “hold control securities,” and should have a legend on the stock certificate indicating that the stock is restricted and cannot be resold in the marketplace without registration. Even after going public or merging, often this stock cannot be sold to third parties due to a number of SEC constraints, even if the stock happens to be registered.

Second, the entrepreneur who merges with another company, which often is part of a plan to “go public,” may be under tax restrictions imposed by the Internal Revenue Code. These limitations generally prohibit the resale of stock, if the parties to the merger want to enjoy the tax-free nature of the transaction. In this scenario, a sale of stock, even if permitted by the SEC, might trigger very adverse tax consequences.

Third, many times in a public offering or a merger, there are contractual restrictions on the stock the entrepreneur owns that are imposed by the company (which goes public or is the survivor in a merger). Typically, these restrictions are mandated in order to make sure that the entrepreneur stays involved with the business, and does not “cash out” and give outside investors a negative impression of the future of the newly formed company. In addition, contractual restrictions may arise as a result of “buy-sell” agreements between key officers and directors of the new company.

Ideas to Maximize Your Family Estate and Charitable Gift Planning Options

Since one or more of these restrictions may exist at any given point in time, you are likely to hear the argument that these restrictions will hamper your family estate and charitable gift planning severely. Especially at a time when it is most advantageous for you to transfer your stock to your family, friends, faithful employees, your foundation, other charities, etc. So, one of the best ways to structure the company’s ownership to maximize your family estate and charitable planning options, prior to going public or merging with another company, may be to first place your stock in a new and separate LLC (or a general or limited partnership). 

By taking this approach, although you cannot transfer your restricted stock to individuals or to charities directly, you can transfer the units in your new LLC according to your family estate and charitable giving plans, rather than the restricted stock itself, thereby achieving your family estate and charitable gift planning goals. 

Understandably, this is a very complex area. Please don’t assume from this basic explanation that it is simple. SEC rules, Federal tax restrictions, and contractual arrangements need to be analyzed carefully to determine, based upon the facts of each case, whether or not placing stock in a new LLC (or partnership) and transferring the underlying LLC units (rather than the stock itself) will effectively avoid these restrictions.

The best time to explore your options and put your plans in place may be right now. Why? It can take many months and even years before you finally go public. Comparatively speaking, things may be much more calm today then they will be and right now might be more conducive for you to kick the tires and learn about your choices so that you are able to implement your plans in a more thoughtful and wise way.

By: Dan Rice, Co-founder of CTAC

Back to the December 2011 eNewsletter