Smart Stock Strategies for Family Businesses

Things to Consider

Don't expect smooth sailing when pricing stock redemptions. Even with a professional appraiser involved, insiders and outsiders can get into real battles over the set value of the stock and how it's going to be valued.

But even then, the stock valuation is not so simple. Says Cohn, "If a business is worth $1 million, for example, and one-quarter of the shares are to be redeemed, the person will not be entitled to $250,000. That's because what is being sold is a minority interest that's non-liquid. Typically, there's a 30 to 40 percent discount for this nonmarketable, minority block."

And there are other variables to consider. Will the stock be valued differently if the person is redeeming simply because he's leaving to pursue another career rather than if he is leaving because he's been swindling the company? Will the value change if some of the stock is voting stock and some of it isn't?

"From an emotional standpoint, it's important for all shareholders to understand that, like an investment, there are price fluctuations in the stock over a period of time," says Eddy. So it's possible that one sibling might redeem 1,000 shares of stock at $50 per share one year, and five years later another sibling might redeem 1,000 shares for $85 each. "Everyone can't be guaranteed they'll get the same amount for the same number of shares," she says.

It's also important to form a plan that delineates how and when the payment of redemptions will be made. Will there be a window of opportunity for redemptions, sometimes from 30 to 90 days annually? Will the payment be immediate and in cash, or will it be spread out over a longer period of time? Will there be a minimum and maximum amount that can be redeemed annually? If shareholders want to redeem more than the company has in its own sinking fund, will all the requests be handled on a pro rata basis, or first-come, first-served?

Stock agreements are also subject to complicated tax laws, and the family should seek the counsel of appropriate accountants and lawyers when designing a stock-redemption plan to see whether the redemption will be treated as ordinary income (and taxed at the individual's normal rate) or as capital gains (and therefore taxed at a lower rate).

The bottom line is that these stock-redemption agreements can be tricky. Because each family is different, the final agreements must be customized. "Ideally, this redemption agreement would be drawn up the minute stock certificates leave the hands of the founders," says Eddy. Whatever its final terms, the plan should aid long-term family ownership, respect the important contributions and the varying needs of both insiders and outsiders, and be as savvy as possible about the tax considerations of redemption.


Patricia Schiff Estess writes family-business histories and is the author of two books: Managing Alternative Work Arrangements (Crisp Publishing) and Money Advice for Your Successful Remarriage (Betterway Press).

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This article was originally published in the August 2000 print edition of Entrepreneur with the headline: Stock of Ages.

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