“I don’t like your cuffs, I don’t like your cuffs, I don’t like your cuffs . . . .” Line by Béarnaise from Mel Brook’s History of the World Part I.
When I begin a conversation on ownership type incentives with owners of early stage companies (and mature ones as well), my typical approach is to discuss the pros and cons of various instruments or techniques. I discuss stock options, restricted stock, phantom plans, profits interest (if an LLC), stock appreciation rights, ESOP’s and the list goes on and on. Inevitably, many instruments are met with disdain much like Béarnaise assessment of Count de Monet’s wardrobe in this famous scene. I must admit in most cases I “feel their pain.”
There always appear to be two challenging issues; the first is offering liquidity and the second is taxes. So let me add a little color to each. First, it appears few entrepreneurs are willing to write a check to buy out a partner / employee / shareholder when they need that cash to grow their business. For a sizable amount, bank financing is not a viable option and introducing a private equity player or sponsor is another kettle of fish. Second, spending an inordinate amount of time structuring the best tax position is not always worth it as it is usually the buyer of the company who will determine tax structure. Simple point; we advise that if you are dealing with a Company transaction, you buy assets and sell stock. Since you can’t have it both ways, if a good deal may not be a great tax deal, you will probably still take it. So what to do?
I have used a technique I call an Equity Bonus Plan for a number of years. It has a handful of simple components:
This plan has now been popularized (I might say plagiarized but imitation is the sincerest form of flattery) by Chobani who announced earlier this year they were adopting a similar plan. (I sound like Al Gore saying he invented the internet.) Though details are a bit sketchy, it appears it will follow a similar path. The liquidity issue becomes a moot point and while proceeds are taxed using ordinary rates, tax payments coincide with the receipt of cash.