BUSINESS DIVORCE: PLANNING FOR WHEN BUSINESSES COME APART, PART 1
& PART 2
First Run Broadcast: June 12 & 13, 2012
1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes each day)
The owners of closely held businesses sometimes decide they can no longer work together. It
may be that the business is not a success and they want to be done with it – or the business may
be a wild success, but they can no longer bear to be in the same company as the other owners.
They want a “business divorce” – to separate the assets of company, each going his or her own
way, perhaps carrying on the business in whole or part. Sometimes the emotional friction that
attends these separations impairs the operating business or diminishes the value of its assets.
This program will provide you with a practical guide to minimizing the adverse consequences of
a business divorce, including effective transactional techniques to separate operating assets while
allowing the business to continue, limiting adverse tax consequences, dealing with
compensation, competition and intellectual property issues, and much more.
Day 1: June 12, 2012:
Planning for a closely-held “business divorce” – practical legal, tax and financial issues
and consequences
Special issues for S Corps, LLCs and partnerships
Transactional techniques short of liquidation to accomplish a divorce, including buy-sell
agreements, compensation and retirement plan techniques
Dividing assets of an operating business while preserving the business
Minimizing adverse tax consequences after a business divorce
Day 2: June 13, 2012:
Special issues in “distressed” business divorces
Valuation techniques for closely held businesses during a business divorce and financing
a buyout
Role of non-competition agreements
Compensation techniques for accomplishing a business divorce
Important intellectual property issues, including customer lists, goodwill and trade secrets
Preservation of valuable tax attributes
Speakers:
Frank Ciatto is a partner in the Washington, D.C. office of Venable, LLP, where he has more
than 20 years’ experience advising clients on major corporate transactions, including mergers
and acquisitions, corporate finance, antitrust and related tax issues. He is a leader of his firm’s
private equity and hedge fund groups and a member of the Mergers & Acquisitions
Subcommittee of the ABA Business Law Section. He is a Certified Public Accountant and
earlier in his career worked at what is now PricewaterhouseCoopers in New York. Mr. Ciatto
earned his B.A., cum laude, at Georgetown University and his J.D. from Georgetown University
Law Center.
Norman Lencz is a partner in the Baltimore, Maryland office of Venable, LLP, where his
practice focuses on a broad range of federal, state, local and international tax matters. He
advises clients on tax issues relating to corporations, partnerships, LLCs, joint ventures and real
estate transactions. He also has extensive experience with compensation planning in closely held
businesses. Mr. Lencz earned his B.S. from the University of Maryland and his J.D. from
Columbia University School of Law.
VT Bar Association Continuing Legal Education Registration Form
Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name: _____________________ Middle Initial: _____Last Name: __________________________
Firm/Organization:____________________________________________________________________
Address:___________________________________________________________________________
City:__________________________________ State: _________ ZIP Code: ______________
Phone #:________________________ Fax #:________________________
E-Mail Address: ____________________________________________________________________
I will be attending:
Business Divorce:
Planning for When Businesses Fall Apart, Part 1 Teleseminar
June 12, 2012
Early Registration Discount By 06/05/2012 Registrations Received After 06/05/2012
VBA Members: $70.00 Non VBA Members/Atty: $80.00
VBA Members: $80.00 Non-VBA Members/Atty: $90.00
NO REFUNDS AFTER June 5, 2012
PLEASE NOTE: Due to New Hampshire Bar regulations, teleseminars cannot be used for New Hampshire CLE credit
PAYMENT METHOD:
Check enclosed (made payable to Vermont Bar Association): $________________ Credit Card (American Express, Discover, MasterCard or VISA) Credit Card # ________________________________________Exp. Date_______ Cardholder: ________________________________________________________
Vermont Bar Association
ATTORNEY CERTIFICATE OF ATTENDANCE
Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: June 12, 2012 Seminar Title: Business Divorce: Planning for When Businesses Fall Apart, Part 1 Location: Teleseminar Credits: 1.0 General MCLE Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.
VT Bar Association Continuing Legal Education Registration Form
Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name: _____________________ Middle Initial: _____Last Name: __________________________
Firm/Organization:____________________________________________________________________
Address:___________________________________________________________________________
City:__________________________________ State: _________ ZIP Code: ______________
Phone #:________________________ Fax #:________________________
E-Mail Address: ____________________________________________________________________
I will be attending:
Business Divorce:
Planning for When Businesses Fall Apart, Part 2 Teleseminar
June 13, 2012
Early Registration Discount By 06/06/2012 Registrations Received After 06/06/2012
VBA Members: $70.00 Non VBA Members/Atty: $80.00
VBA Members: $80.00 Non-VBA Members/Atty: $90.00
NO REFUNDS AFTER June 6, 2012
PLEASE NOTE: Due to New Hampshire Bar regulations, teleseminars cannot be used for New Hampshire CLE credit
PAYMENT METHOD:
Check enclosed (made payable to Vermont Bar Association): $________________ Credit Card (American Express, Discover, MasterCard or VISA) Credit Card # ________________________________________Exp. Date_______ Cardholder: ________________________________________________________
Vermont Bar Association
ATTORNEY CERTIFICATE OF ATTENDANCE
Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: June 13, 2012 Seminar Title: Business Divorce: Planning for When Businesses Fall Apart, Part 2 Location: Teleseminar Credits: 1.0 General MCLE Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.
PROFESSIONAL EDUCATION BROADCAST NETWORK
Speaker Contact Information
Business Divorce: Planning For When Businesses Come Apart,Part 1 & Part 2
Frank CiattoVenable LLP - Washington, D.C.(o) (202) [email protected]
Norman LenczVenable LLP – Baltimore, Maryland(o) (410) [email protected]
1
© 2008 Venable LLP
BUSINESS DIVORCES
2
Business Divorces
© 2012 Venable LLP
The 50/50 Partnership Conundrum
Tiebreaker provisions are critical
Valuation Methodology
S Corp v. LLC Tax Issues
Overview of Planning for a Closely-Held “Business Divorce” –
Practical Legal, Tax and Financial Issues and Consequences
3
Business Divorces
© 2012 Venable LLP
For C Corp – capital gain vs. dividend treatment
for redeemed stockholder is the biggest issue
Currently, same 15% tax rate for capital gains
and dividends
Dividend rate set to increase to over 40% in 2013
Special Issues for S Corps, LLCs and Partnerships
4
Business Divorces
Capital gain vs. dividend issue is generally less
important than in the C Corp context
Buy-Sell Agreement at time of formation is
absolutely crucial to ensure compliance with S
Corp rules
Buy-Sell Agreement should prohibit transfers to
ineligible S Corp shareholders such as
1. certain types of trusts
2. corporations
3. multi-member LLCs
4. nonresident aliens
© 2011 Venable LLP
Special Issues for S Corps
5
Business Divorces
Special allocations, disproportionate distributions
and multiple classes of stock are prohibited,
which limits flexibility in the business divorce
context
Distributions of appreciated property are
generally taxable, unless a tax-free spin-off is
feasible
No “look-through” to ordinary income assets on
transfer or redemption of S Corp stock
© 2011 Venable LLP
Special Issues for S Corps (cont’d)
6
Business Divorces
Special allocations, disproportionate distributions
and multiple classes of interests may be used to
effect a “separation” vs. a “divorce”
Appreciated property can generally be distributed
tax-free
Basis step-up inside the LLC/partnership (Section
754 election)
© 2011 Venable LLP
Special Issues for LLCs and Partnerships
7
Business Divorces
Because of flow-through tax treatment, tax
distributions should be mandatory
Election to “close the books” upon transfer or
redemption of stock/interests is generally
available
Cross-Purchase vs. redemption issues should be
considered
Cash can generally be distributed tax-free to the
extent of tax basis in stock/interest
© 2011 Venable LLP
Issues Common to S Corps, LLCs and Partnerships
8
Business Divorces
© 2012 Venable LLP
Buy-Sell Provisions
Russian Roulette
Right of First Offer
Right of First Refusal
Sale upon Divorce (mandatory or optional)
Sale upon Termination (mandatory or
optional)
Consulting Arrangements
Retirement Payouts/Installment Sales
Transactional Techniques Short of Liquidation to Accomplish a
Divorce, including Buy-Sell Agreements, Compensation and
Retirement Plan Techniques
9
Business Divorces
© 2012 Venable LLP
Considerations:
Discrete Business Lines
Payroll, Accounting and Financial Reporting
Functions
Office Space
True Separation v. One Partner Providing
Management Functions to Other
Dividing Assets of an Operating Business While Preserving the
Business, including Spinoffs
10
Business Divorces
© 2012 Venable LLP
Will the separation be accomplished in a taxable
or tax-free manner?
Will the separation be accomplished through a
redemption or a cross-purchase?
Will a basis “step-up” be available?
Will post-closing consultation or compensation
arrangements be used to maximize tax
efficiencies?
Minimizing Adverse Tax Consequences Pursuant to a Business
Divorce
11
Business Divorces
© 2012 Venable LLP
Deeper pocket partner has increased leverage to
absorb a forced financial loss
If Company has cash flow concerns, it likely
means longer payout period and more risk to
departing partner
Distressed scenario means unlikely or harder to
pay salary to non-contributing/departing owner
Departing partner becomes another in a line of
claimants against Company and will be viewed as
an “Insider” for bankruptcy purposes
Business “stress” likely to make a deal among
knowing partners harder to consummate
Special Issues in “Distressed” Business Divorces
12
Business Divorces
© 2012 Venable LLP
Three primary approaches
Asset
Income
Market
Multiple valuation methodologies available under
each of these three approaches.
Financing Options
Life Insurance
“Seller” Financing
Third-Party Debt
Valuation Techniques for Closely Held Businesses During a
Business Divorce and Financing a Buyout
13
Business Divorces
© 2012 Venable LLP
Identifying and defining assets owned by business(and not individually by founding partners) is criticalbusiness divorce objective
Protecting Company assets through:
Confidentiality Provisions
Noncompetition and nonsolicitation provisions
Trade secret and intellectual property provisions
Provisions Need to be Supported by ValidConsideration and Narrowly Drawn to OptimizeEnforceability
Pro-competitive Business Divorces
Lower purchase price and no barriers to entry
Free-for-all environment should still bedocumented
Role of Non-Competition Agreements & Important Intellectual
Property Issues, Including Customer Lists, Goodwill and Trade
Secrets
14
Business Divorces
© 2012 Venable LLP
Installment Sale or Promissory Note
Employment Agreement (usually to maintain
benefits)
Consulting Agreement
“True” consulting
Disguised purchase price
Earn out or other post-closing profits-based
consideration
Compensation Techniques for Accomplishing a Business
Divorce
15
Business Divorces
© 2012 Venable LLP
C Corp NOL preservation is most crucial issue
Must avoid an “ownership change” (i.e., change
of 50 “percentage points” of ownership over any
3-year period)
In corporate, LLC and partnership “spin-offs”,
must allocate tax attributes among the surviving
entities
Preservation of Valuable Tax Attributes
16
© 2012 Venable LLP
Contact Information
Frank A. Ciatto, Partner
t 202.344.8150
f 202.344.8300
YOUR VENABLE TEAM
Norman Lencz, Partner
t 410.244.7842
f 410.244.7742
www.Venable.com
17
© 2011 Venable LLP
the road ahead forABC CORPORATION
Thank you for attending.
308998
BY
FRANK A. CIATTO
VENABLE LLPWASHINGTON, D.C.
1. TYPE OF CORPORATION
(a) C corporation
(b) S corporation
2. PARTIES TO THE AGREEMENT
(a) All shareholders
(b) If not all shareholders, how will excluded shareholders be dealt with
3. GOVERNANCE
(a) Vote pooling arrangements for Board of Directors and officers.
(b) Shareholder voting arrangements and veto rights over certain corporate actions.
(c) Minority shareholder protections.
4. TRANSFERABILITY OF SHARES
(a) Permitted lifetime transfers to third parties
(i) Rights of first refusal
(ii) Gifts – outright and in trust
(b) Pledges
(c) Tag along rights
(d) Drag along rights
5. STOCK BUYOUT PROVISIONS
(a) Triggering events:
308998
- 2 -
(i) Death
(ii) Disability
(iii) Retirement
(iv) Termination of employment
Voluntary
Termination with/without cause
Termination for good reason
(v) Removal/resignation from Board of Directors
(vi) Other buyout events
Bankruptcy of shareholder
Loss of professional license by a shareholder if entity is a professionalcorporation or association
Dissolution or change of control of corporate or other entity-ownedshareholder
Shareholder providing services to, or owning an interest in, a competingbusiness
(vii) Russian roulette provisions
(b) Mandatory versus optional buyouts
(i) Cross-purchase versus redemption
(ii) Possible buyout scenarios:
Corporation and other shareholders have an obligation to purchase thestock and the shareholder has an obligation to sell
Corporation or other shareholders have an option to purchase (i.e., call)the shareholder’s stock
Shareholder has an option to sell (i.e., put) the stock to the corporationor other shareholders
Coexistent cross-options between the shareholder and the corporation(and/or other shareholders)
308998
- 3 -
(c) Consider buyouts in related entities that do business with the corporation
6. STOCK PURCHASE PRICE CONSIDERATIONS
(a) Book value
(b) Capitalization of earnings formula
(c) Discounted cash flow formula
(d) Appraisal procedure
(e) Annual valuation updates
(f) Use of minority discounts and control premiums
(g) Contingent purchase price adjustment if corporation experiences a “change ofcontrol” transaction
7. PAYMENT TERMS UPON PURCHASE OF STOCK
(a) Cash
(b) Insurance funding
(c) Bank financing
(d) Selling shareholder financing
(i) Payment term
(ii) Frequency of payments
(iii) Rate of interest
(iv) Collateral
(v) Guarantees
(e) Restrictions on annual deferred payments if there have been multiple stockbuyouts
8. PLANNING FOR OTHER CORPORATE STRATEGIES
(a) Initial public offering
(b) Lock-up agreements
(c) Demand or piggyback registration rights
308998
- 4 -
9. TAX CONSIDERATIONS
(a) Buyouts of stock
(i) Qualification as sale or exchange under I.R.C. Section 302 for corporaterepurchase; evaluate any potential impact of family attribution rules underI.R.C. Section 318
(ii) Installment reporting under I.R.C. Section 453 for deferred payments
(iii) Avoidance of imputation of interest for deferred payments under I.R.C.Section 1272
(iv) Alternative minimum tax considerations under I.R.C. Sections 55 and 56 iffunding with corporate-owned life insurance in the case of a C corporation
(v) Stock basis implications associated with cross-purchase versus redemption
(b) S corporation considerations
(i) Preservation of S corporation status, including safeguards against thirdparty transfers to impermissible S corporation shareholders
(ii) Imposition of liability upon shareholders who jeopardize S corporationstatus
(iii) Permitting periodic distributions to shareholders to cover tax liability onallocable share of S corporation taxable income
10. STATE CORPORATE LAW RESTRICTIONS ON CORPORATE REPURCHASES
11. RESTRICTIVE COVENANTS
(a) Confidentiality agreement
(b) Assignment of intellectual property rights
(c) Covenants against competition and solicitation of customers and employees
(d) Duration and scope of restrictions
(e) Specify civil and equitable remedies in the event of a breach
12. MISCELLANEOUS CONSIDERATIONS
(a) Indemnification for guarantees of corporate obligations
(b) Indemnification of officers and directors
308998
- 5 -
(c) Dispute resolution
(i) Mediation
(ii) Arbitration
(iii) Judicial
13. AMENDMENT OF AGREEMENT
(a) Unanimous?
(b) Less than unanimous?
(c) Combination of (a) and (b) depending upon the event triggering an amendment?
14. TERMINATION OF AGREEMENT
(a) Use a date certain
(b) Buyout of a certain number or percentage of shareholders
(c) Agreement by shareholders
(d) Survivability of certain provisions post-termination
Special Buy-Sell Provisions for S Corporations
In addition to the normal provisions of a buy-sell agreement for a regular corporation, the
agreement entered into by the owners of an S corporation (and the corporation itself) must
contain a number of provisions mandated by the tax status of the corporation, so as to preserve
the S election status of the corporation.
1. The agreement should grant an immediate option to the corporation and other
shareholders to purchase any stock whose transfer would jeopardize the S
election, exercisable at a price which the corporation and the remaining
shareholders determine, in their sole discretion, to be “fair” and to hold the
transferor liable for any damages which are incurred either by the corporation or
the remaining shareholders as a result of the attempted transfer.
2. The agreement should permit lifetime or testamentary transfers to trusts for
descendants of shareholders or others, only if the trust is either a Qualified
Subchapter S Trust1 or an Electing Small Business Trust.2 Some agreements go
on to require the consent of the other shareholders and an opinion of counsel that
the transfer will not jeopardize the S election.
3. The owners of the S corporation should give consideration to the income tax
consequences of a withdrawing shareholder. Unless an election were made under
Code Section 1377(a)(2), all income and losses for the entire year are allocated on
a per day basis, with the withdrawing shareholder bearing the tax consequences
on his or her proportionate interest.
1 Code Section 1361(d). 2 Code Section 1361(e).
C:\Documents and Settings\Nathaniel Trelease\My Documents\My Files\WebCredenza\Teleseminars\Programs\2008\Business Divorce\May 20-21, 2008 material (3 of 6).DOC
A 1377(a)(2) election, on the other hand, would permit the S corporation to
allocate income and losses as though there were two tax years: one ending upon
the withdrawal of the shareholder and the second beginning on the day after that
event. This election permits the terminating shareholder to avoid the
consequences (or to share in the benefits) of post termination income and losses to
the corporation.
The agreement might require that all of the shareholders of the S corporation
agree to make the 1377(a)(2) election.3 The agreement should go on to provide
that the departing shareholder should actually receive the net income earned by
the S corporation up to the termination of his interest, in view of the fact that he is
being taxed on those earnings.
4. The value paid for the interest of the departing shareholder should reflect any
increased income tax liability which is thereby imposed upon the remaining
shareholders.
5. The agreement should deal with the possibility that a corporate redemption may
not qualify for capital gains tax treatment in the hands of the departing
shareholder.
If the redemption does qualify as a sale or exchange, the departing
shareholder will have taxable gain only to the extent the payment received
exceeds his basis and only a proportionate share of the corporation’s accumulated
adjustment account t (AAA) is deemed to have been distributed.
If the redemption does not qualify as a sale or exchange, on the other
hand, the order of distributions is as follows: (a) the distribution is non-taxable to 3 Regulations Section 18.1377-1.
C:\Documents and Settings\Nathaniel Trelease\My Documents\My Files\WebCredenza\Teleseminars\Programs\2008\Business Divorce\May 20-21, 2008 material (3 of 6).DOC - 2 -
the extent it does not exceed the corporation’s AAA; (b) any excess distribution
over that is treated as a dividend subject to ordinary income taxation to the extent
of the corporations’ accumulated earnings and profits; (c) any excess distribution
over that is treated as a non-taxable return of basis; and (d) any excess distribution
over that is treated as a capital gain distribution. If the shareholder’s stock is
redeemed as a result of his death and the agreement is funded with insurance on
the shareholder’s life, there can be significant dividend problems. That is, the
receipt of the insurance proceeds increases the basis of the shareholders, but does
not increase AAA. If the redemption proceeds exceeds the corporation’s AAA
(which is not increased by the amount of the insurance proceeds), dividend
treatment to the deceased shareholder may result.
6. If the redemption takes place by the distribution of appreciated assets of the S
corporation, there is a deemed sale of those assets, with any gain reportable by all
the shareholders. The impact of this consequence on the remaining shareholders
should be taken into consideration when the redemption price is determined under
the agreement.
7. The agreement should prohibit loans, stock options or other transactions which
would constitute a second class of stock.
8. The agreement should provide that the corporation will, at a minimum, distribute
at least quarterly sufficient dividend income to enable the shareholders to pay
their resulting income tax liability. Care should be exercised, however, to avoid
the second class of stock argument by distributing the same amount pro rata
C:\Documents and Settings\Nathaniel Trelease\My Documents\My Files\WebCredenza\Teleseminars\Programs\2008\Business Divorce\May 20-21, 2008 material (3 of 6).DOC - 3 -
among all the shareholders and not basing distributions on their relative tax
brackets.4
4 Regs. Section 1.1361-1(a)(2)(v), Example 6.
C:\Documents and Settings\Nathaniel Trelease\My Documents\My Files\WebCredenza\Teleseminars\Programs\2008\Business Divorce\May 20-21, 2008 material (3 of 6).DOC - 4 -
C:\Users\Nathaniel Trelease\Documents\My Files\WebCredenza\Teleseminars\Programs\2012\Business Divorce (6-12 & 13-12)\June 12 & 13,2012 material (3 of 4).doc
BUSINESS DIVORCE – MAJOR TAX ISSUES
byNorman LenczVenable LLP
Tax issues inevitably arise during the course of any business separation. If one
business owner or group of owners buys the interest of another business owner or group of
owners for cash, the transaction will be taxable. In other circumstances, however, the parties
often can accomplish their business separation on a tax-free basis. In all circumstances, the
parties should consider the tax issues arising in their business divorce and balance those issues
with the other business issues involved in the overall transaction. The questions listed below
represent some of the major questions that are likely to arise during any business divorce
negotiation.
1. Will the Separation be Accomplished in a Taxable Cross-Purchase?
(a) Buyouts for Cash
(i) Tax Consequences to Seller
(ii) Tax Consequences to Buyer
(b) Buyouts for Notes
(i) Tax Consequences to Seller
(ii) Tax Consequences to Buyer
(c) Buyouts for Other Property
(i) Tax Consequences to Seller
(ii) Tax Consequences to Buyer
C:\Users\Nathaniel Trelease\Documents\My Files\WebCredenza\Teleseminars\Programs\2012\Business Divorce (6-12 & 13-12)\June 12 & 13,
2012 material (3 of 4).doc - 2 -
2. Will the Separation be Accomplished in a Taxable Redemption?
(a) Redemption v. Cross-Purchase
(b) Corporate Redemptions
(i) Tax Consequences to Seller
(ii) Tax Consequences to the Company
(iii) Tax Consequences to the other Shareholders
(c) Partnership/LLC Redemptions
(i) Tax Consequences to Seller
(ii) Tax Consequences to the Company
(iii) Tax Consequences to the other Partners
(d) Efficiencies in Making Deductible Payments
3. Can the Separation be Accomplished on a Tax-free basis?
(a) Unavailability of Section 1031
(b) Separating C and S corporations
(i) Spin-offs, Split-offs and Split-ups
(ii) Consequences of Qualifying under Section 355
(iii) Consequences of Failing to Qualify under Section 355
(iv) Qualification under Section 355
(1) Business purpose requirement
(2) Active trade or business requirement
(3) Continuity of interest
(4) Change of control limitations
C:\Users\Nathaniel Trelease\Documents\My Files\WebCredenza\Teleseminars\Programs\2012\Business Divorce (6-12 & 13-12)\June 12 & 13,
2012 material (3 of 4).doc - 3 -
(5) Continuity of business enterprise
(6) Other requirements
(c) Separating Partnerships and LLCs
(i) General Partnership Distribution Rules
(ii) Exceptions
(1) non pro rata distributions
(2) disguised sales
(3) anti-mixing bowl rules
(d) Effect of Continuing Interests
4. Will any Special Compensation Issues Arise?
(a) Efficiencies in Making Deductible Payments
(b) Treatment of Stock Options and other Equity Compensation
(c) Splitting 401k Plans
(d) Consequences of Termination of Employment
5. Will any Valuable Tax Attributes Need to be Preserved?
(a) Taxable Corporate Separations
(i) General Rules
(ii) Impact of Section 382
(b) Tax-free Corporate Separations
(c) Partnerships and LLCs