Success Stories

Mike
Age: 50

Objective

Use stock compensation from a prior career to purchase an established small business in a tax savvy manner.

The Situation

Mike had been the director of a major, publicly traded company for the last ten years.  Throughout his career he’d been paid in company stock in addition to a cash salary.  It was time for a change, and he’d always wanted to run a small business.  Rather than launch one from the ground up, he wanted to use the equity compensation he’d accumulated to purchase an existing business.  He had a substantial mix of restricted stock units, incentive stock options and non-statutory options.  While he had substantial resources, he had no idea how to minimize taxation while maximizing the benefit of the shares.  Nor did he know how best to structure the purchase of the business he wanted to pursue.

The Strategy

Mike’s stock compensation consisted of a mix of restricted stock units (RSUs), performance share units (PSUs), and non-statutory options (NSOs).  Of all the vested shares he could take with him after departing, the vast majority were RSUs and PSUs.

We started forecasted Mike’s income over the subsequent 10 years and laying out a cash plan for his personal expenses.  While Mike didn’t quite know the exact purchase price he’d be looking at in the business purchase, he estimated it’d be between $2 million and $4 million.

When he found a suitable deal brought to him by his business broker, Mike quickly went through discussions with the seller & signed a letter of intent with a $3 million purchase price.  He put down earnest money soon after & began going through due diligence.  He’d need to put $500,000 down, and the remaining $2.5 million would be financed by the seller.

While Mike had plenty of RSUs and PSUs available to sell, we decided to sell only $200,000 worth of recently vested shares.  These recent lots could be sold with minimal capital gains, reducing taxation.  The remaining $300,000 he needed for the down payment would be borrowed, using the other shares as collateral.  While he’d need to pay interest on the loan, it was far less expensive than selling older lots and triggering capital gains taxation.

The options needed to be exercised over the subsequent four years before they’d expire.  We mapped out a plan to do so in a way that minimized tax impact but provided the cash flow he’d need to pay his personal expenses.  While he was confident in his ability to draw an income from the newly purchased business, this was new to Mike and he wanted a reasonable margin for error.

The Results

Mike closed on the purchase of the business six months after beginning discussions with the seller.  He was able to use his company shares as collateral for the down payment, which helped him avoid triggering substantial capital gains.  And even though a drop in the value of his shares could impact the value of the options he hadn’t yet exercised, he had a sizable cash emergency fund he could use if necessary.

Once Mike settled into his role running the new business, we helped him set up a 401(k) plan and other employee benefits.  This had the dual benefit of helping Mike defer salary and profits from taxation, but also help retain employees after the transition.