Share and share alike: a stock redemption plan lets family members sell shares while staying in the business - Family Business

Entrepreneur, June, 1996 by Patricia Schiff Estess

WHO CAN PICTURE what a family business will look like if it survives into second and third generations? From a simple mom and pop operation might spring 25 or 30 shareholders--siblings, cousins, aunts, uncles, nieces, nephews, widowed in-laws and a raft of other relatives.

Even assuming the group is devoted to each other, there are plenty of reasons one or more may want to redeem all or some shares of stock. Whether actively involved in the business or not, one family member might need money for a down payment on a house or tuition to graduate school. Another might be going through a divorce and need cash for a settlement. Another might want the money to start his or her own company, or feel it would be better invested elsewhere.

And in the more typical family situation--where a few inactive shareholders disagree with those in control about the business's philosophy or future direction--some family members may want out, wholly or partially, because stock ownership is no longer personally or financially gratifying for them.

For these reasons and more, creating a stock redemption plan is important as soon as more than one person owns stock in the business. In addition to giving shareholders liquidity, such a plan "lets shareholders know they can sell part of their stock and still stay connected to the family business," says Mike Cohn, a family business consultant and president of The Cohn Financial Group Inc. in Phoenix.

Each company's stock redemption plan needs to be molded to fit its unique structure and circumstances. And since all financial transactions of this type are complex, it should be discussed and reviewed with legal and business advisors.

Shareholders should consider who they want to own the stock (direct descendants only? in-laws? outsiders?); how shares will be valued; what events (such as withdrawal as an active member of the business or the death of the founder) will trigger redemption; how corporate and personal taxes will be affected; and how to structure a plan so the company's cash flow isn't hurt.

While a multitude of techniques exist for financing shareholder liquidity internally (such as paying dividends, setting up a company sponsored loan program that uses the shareholder's stock as collateral, and redeeming a shareholder's stock for a company asset instead of cash), here are three other possibilities to consider:

1. An annual shareholder redemption plan that allows shareholders to sell stock to the company (or in some cases to other shareholders) during a set period each year at a price set by a formula. "Because each year the company determines how much money is available for this purpose, it doesn't get locked into an onerous commitment that puts shareholders' liquidity needs ahead of its own," explains Cohn. "Yet shareholders have emotional permission to use their shares as they see fit without feeling disloyal when they want to sell." (For shareholders who are worried they'll miss out on windfall profits if they sell shares and insiders later sell the company to a third party, a provision can be added allowing recent sellers to recoup most of the difference between the price they received and what insiders received from the third-party sale.)

It has been only a year since Jayco Inc. instituted an annual shareholder redemption plan, and it hasn't been invoked yet. But Wilbur Bontrager, chairman of the Middlebury, Indiana, motor home manufacturing firm, says it's important because you never know what family members' needs will be down the road. As in most family businesses, the largest percentage of each member's estate is made up of company stock. Now, if any of the five Bontrager siblings (two actively involved in the business, three not, but all shareholders) need cash, they have liquidity.

2. Installment repurchases of stock. By buying back stock over an extended period of time, the company has a way "to meet relatively large demands for liquidity in planned stages so it doesn't face a financial drain," says Jeffrey A. Galant, partner in Goodkind Labaton Rudoff & Sucharow LLP, a New York City law firm specializing in family businesses. Other pluses are that the company has the opportunity to lock in a price for stock and plan for future expenditures.

3. An Employee Stock Ownership Plan (ESOP). This is not practical for very small companies because it entails considerable setup and ongoing costs, but it can work for slightly larger companies. Once an ESOP holds 30 percent or more of the company's stock, shareholders can gain liquidity by selling stock to the ESOP on a tax-deferred basis.

Setting up a stock redemption plan acknowledges the need for liquidity both for individual shareholders and in business. If a family member can't sell stock, he or she becomes frustrated and disenchanted, which can only lead to rifts within the business.

Patricia Schiff Estess publishes the newsletter Working Families and is the author of two new books, Managing Alternative Work Arrangements (Crisp Publications) and Money Advice for Your Successful Remarriage (Better way Press).