SELLING A COMPANY TO ITS EMPLOYEES
Business owners planning for retirement generally contemplate either the sale of the business to a third party or a transfer of ownership to family members, but another option may be to sell the business to company employees. There are several techniques and issues to consider when planning this type of sale.
Initial Transfers. The sale of a business to its employees often starts with purchases of minority interests (stock or limited liability company (“LLC”) membership interests), sometimes through installment payments. For the selling owner, maintaining voting control until the sale is completed is important and can be ensured by barring minority interests from being transferred to outside parties or by only transferring nonvoting interests. Employees should file an Internal Revenue Code Section 83(b) election (within 30 days of the purchase), so that capital gains treatment is available for a future sale of the business interests.
Financing and Redemption. Employees often do not have sufficient cash to purchase the entire business. An alternative to a bank loan or seller financing is the redemption by the company of the remaining equity interests not previously sold or transferred to employees. Capital gains treatment can be obtained for a corporation under Code Section 302, which essentially requires a complete termination of interest. Distributions from Subchapter S corporations or limited liability companies taxed as a partnership have different tax attributes, and the accumulated earnings may have already been taxed.
ESOPs. Another technique to sell equity interests to employees is to create an employee stock ownership plan (an “ESOP”), which can purchase stock using bank loans. The yearly contributions to an ESOP are deductible as retirement plan contributions, with the loan to the ESOP repaid from the yearly plan contributions. For a “C” Corporation, there is a tax deferral technique if the owner rolls over the sale proceeds into qualified U.S. domestic corporation replacement securities and if at least 30% of the company stock is sold to the ESOP. If the owner holds the new qualified domestic corporation replacement securities until death, a stepped-up basis under Code Section 1014 could eliminate the capital gains tax upon a sale of the replacement domestic corporation securities.
Securities Law Issues. The sale of equity interests to employees also involves an analysis of federal and state securities law registration exemptions and general securities law requirements. All securities transactions require adequate disclosure of material facts to avoid securities anti-fraud claims. Illinois has a securities law exemption for the sale of stock within the state if the sale is to less than 35 purchasers. Illinois also exempts sales solely to existing shareholders. For federal securities law purposes, U.S. Securities and Exchange Commission (“SEC”) Rule 506 provides an exemption for sales that are limited to not more than 35 persons who are not accredited investors, but who have enough sophistication to understand the investment they are making. SEC Rule 701 provides an exemption for sales solely to employees.
Conclusion. The sale of the equity interests to employees is a natural way to transfer the ownership of a company to persons who are knowledgeable about its operations and capable of running the business. The successful implementation of this type of transaction requires an evaluation of financing techniques, tax and securities law issues, and methods to maintain control until all the equity interests have been sold.
By Ronald G. Silbert
EMPLOYMENT DISCRIMINATION CLAIMS GET EASIER TO PROVE
Over the past several years, it has become increasingly difficult to determine what types of evidence are needed for an employee or ex-employee to have a viable discrimination claim. A recent decision of the Court of Appeals for the Seventh Circuit, which covers Illinois, Wisconsin and Indiana, provides some clarity as to what is necessary and makes it easier for employees to prevail in a discrimination case.
Federal courts traditionally identified two different methods by which employees could prove employment discrimination claims. A defendant’s rare admission that it engaged in discrimination or other “smoking gun” proof is classified as direct evidence. Consider the experienced employee passed over for a promotion whose supervisor states: “your retirement is in sight, and we’re hoping to find someone who will stay with the company for years.”
More commonly, where evidence of overt discrimination is lacking, a plaintiff claiming discrimination must use indirect evidence. This is typically done by asserting that a “similarly situated” employee outside a protected category has been treated more favorably than the employee claiming discrimination. For example, indirect evidence of a termination motivated by discrimination may be shown when the same supervisor who fires a black employee for four incidents of tardiness retains a white employee with five tardies.
Courts have criticized the direct/indirect evidence dichotomy as simplistic, but on a somewhat inconsistent basis. Some evidence, such as suspicious timing, ambiguous statements, or discrimination against other employees in the same protected class, cannot be pigeonholed either as direct or indirect evidence, although courts recognize that such evidence can prove discrimination. Therefore, trial courts have been directed to look at the different types of evidence presented by an employee to determine whether, in the aggregate, it comprises a “convincing mosaic” of discrimination.
In a stinging decision handed down on August 19, 2016, the Seventh Circuit emphatically rejected the focus on the “rat’s nest of” direct/indirect tests and convincing mosaics, noting they have “complicated and sidetracked employment-discrimination litigation for years.”
The decision came in Ortiz v. Werner Enterprises, Inc., arising from Henry Ortiz’s termination by a shipping company. Ortiz alleged he was fired due to his Mexican ethnicity, pointing to slurs directed at him throughout his tenure. Werner countered he falsified business records, although Ortiz asserted that he was merely correcting records improperly blaming him for losses.
The appellate court reversed the lower court’s dismissal of Ortiz’s claims for failing to paint “a convincing mosaic of discrimination,” rejecting talk of mosaics and direct/indirect methods of proof. The appropriate inquiry in all further employment cases were simplified: “Whether a reasonable juror could conclude that Ortiz would have kept his job if he had a different ethnicity, and everything else had remained the same.”
Finding Ortiz had presented sufficient evidence to convince a reasonable juror that Werner “didn’t much like Hispanics,” and that he was fired for using techniques tolerated when practiced by other brokers, the appellate court held he was entitled to a trial on his allegations of discrimination. The employment discrimination focus must be on whether the evidence shows that “the plaintiff’s race, ethnicity, sex, religion, or other proscribed factor caused the discharge or other adverse employment action.”
The Ortiz ruling opens many new avenues for disgruntled employees to prove adverse actions were motivated by discrimination. Employers should take immediate notice and make sure that any decision to discipline an employee is both well-documented and supported by legitimate business reasons.
By Adam J. Glazer
Introducing Joan T. Berg
Attorney Joan T. Berg has joined the Firm as a partner in the Real Estate & Finance Department. Joan represents municipalities, real estate owners, investors, lenders and corporations. She assists owners and investors in acquisitions, dispositions, financing, zoning and land-use matters. She represents lenders in asset and cash-flow financing and construction and real estate-based financing, including commercial mortgage backed securities and defeasance matters. Joan counsels businesses on general corporate matters, acquisition and sale of subsidiaries, joint ventures, development of new facilities and financing. In 2016, Joan was chosen by Illinois Leading Lawyers™ as one of the top 100 Women in Real Estate.
SFNR In The News
Firm partners Norm Finkel and Dan Beederman, and the formation of SFNR, were featured in an article in the August 2016 edition of the American Bar Association Journal. The article can be viewed by clicking on the following: http://www.abajournal.com/magazine/article/law_merger_schoenberg_finkel_newman_rosenberg
Firm partners Dan Beederman and Bruce Bell will be making presentations at the Annual Conference of the Association of Independent Manufacturers’/Representatives, Inc. (“AIM/R”) in Miami, Florida on October 18 and 19, 2016. Dan will address the different business relationships faced by independent sales representatives, while Bruce will speak on the purchase and sale of sales representative businesses in a tax-efficient manner.
Schoenberg Finkel Newman & Rosenberg, LLC (312) 648-2300
This newsletter is not intended to be legal or tax advice and is not a substitute for obtaining legal or tax advice. This Newsletter is deemed to be advertising material by the Illinois Supreme Court.