A Wide-Angle Lens to Shareholder Agreement

A building contractor granted 10% of the company to a newly promoted COO. Given its large accounts receivable balance, the company had to borrow nearly $2M to cover the taxes on this grant.

We shared there is an alternative to achieve a near identical outcome and zero tax cost (meaning a $2M tax savings). Hearing this, the owners almost blew a gasket. Our suggestion: issue Profits Interests in their LLC with a catch-up provision that, over time, looks and feels just like traditional restricted equity.

For more information on Profits Interest, see Mark Bronfman’s article on “The Profits Interest”.

The lesson: embrace the logical before the legal. We develop a “value sharing curve” model prior to having the attorneys draft the legal plans. The model tests the value architecture, specifically in regard to how executives and owners get in, share value and eventually leave the business in style.

The value sharing curve has a critical advantage – it works the problem from the end, not the beginning. Outline what the financials of a business could look like in the extreme. Keep iterating the design until you enhance the chance of success. Reduce the risk of cash flow or value failure. Try things like:

• Use profits interests instead of restricted equity.
• Model long term cash flows based on extreme scenarios
• Use multiple values in a single shareholder agreement for buy-in and buy-out
• Add SARs to a phantom stock plan.
• Consider time-to- value rewards via EVA or Performance Share Plans
• Consider choice of entity across C, S or LLC to achieve an end goal.
• Promote control incentives (such as vote, right to hire/fire) in lieu of traditional incentives
• Add debt governors to installment buyouts

These modifications viewed through the wide-angle lens of the value sharing curve can potentially benefit a buy-sell arrangement, a shareholders agreement or an executive compensation plan.

Want to know more about resilient executive compensation, equity strategies and exit planning? We can help.

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