Planning for Closely Held Business Owners (Section IV.B) (10%, 12-13 Questions) Flashcards
1
Q
Angel Investors
A
- Angel investors typically form groups to provide equity financing to start-up companies. Angels
should be considered if the new business owner(s) cannot qualify for adequate bank financing, but still require outside financing. Because angels can set their own terms, care should be taken when
negotiating this financing.
2
Q
Venture Capital
A
- Venture capital firms (VCs) provide financing for high growth companies in exchange for significant equity. VCs are generally funded by risk-tolerant private investors who seek high returns within a
short period of time. VCs typically strive for annual returns of at least 20 percent to 40 percent with investment periods ranging from three to seven years.
3
Q
Mezzanine Financing
A
- Mezzanine financing may be characterized by a hybrid type of security, junior to venture capital and senior debt, often requires little to no collateral, equity conversion feature in case of default.
4
Q
Leveraged Buyouts
A
- At its most basic level, an LBO is a method of acquiring a company with money that is nearly all borrowed. This allows
investors to make a large acquisition without committing a lot of capital. The acquirers of the target company often attempt to sell or take the target company public after five or ten years in the hopes of making sizable profits.
Doing an LBO can be expensive and complex, but if successful can provide considerable returns.
5
Q
Distressed Debt
A
- Distressed or special situations. This is a broad category referring to
investments in equity or debt securities of financially stressed companies. Since this area focuses on investing in entities that are in default, under
bankruptcy protection, or headed in that direction, investors must evaluate not only the ability for the entity to make a comeback, but also
which class of securities might be more beneficial to hold during a restructuring process.
6
Q
Restructuring
A
- Restructuring includes mergers, acquisitions, divestitures, recapitalizations, leveraged buy-outs, reorganizations, downsizings, and other types of restructuring of a corporation. During the 1980s, the value (i.e., prices paid or revenue impact) of these
activities in corporate America was over $300 billion. The value of leveraged buy-outs alone was over $80 billion. In only a five-year period in the 1990s this value was
equaled.
7
Q
C-Corporations
A
- A corporation is a unique entity that is separate and distinct from its shareholders. A corporate shareholder is only liable for corporate debts and liabilities to the extent of his or her investment in
the corporation. - The corporate structure may be appropriate for businesses with the following characteristics:
-Multiple owners
-Multiple types of owners
-Need for limited liability
-Need for continuing life
-Future intentions to go public
-Future intentions to acquire other companies by merger
-Exit strategy involving tax-free reorganization
-Desire to retain taxation at the entity level.
8
Q
S-Corp
A
- Many closely held corporations are eligible to elect to be taxed under Subchapter S instead of under the regular rules for taxation of corporations. If the election is made, the corporation’s income, with some exceptions, is not taxed at the corporate level but is passed through and taxed to its shareholders. Thus, an electing corporation avoids double taxation of its income.
Under the regular corporate income tax rules, a corporation pays a tax on its taxable income. - When considering an S corporation as a business entity, the following matters should be noted:
1. Shareholder-employees must be compensated with wages, subject to withholding.
2. Distributions, or dividends, must always be proportional to stock ownership.
3. Only one class of stock is allowed. Thus, the corporation cannot have preferred stock or any other
class of stock that differs from another in any aspect other than voting rights.
4. Non-U.S. persons cannot be added as shareholders nor can a current “community property”
shareholder marry a non-U.S. person.
5. Reasonable compensation must be paid to shareholder-employees.
9
Q
LLC
A
- A limited liability company (LLC) is created by state law. As discussed previously, an LLC generally has the flexibility of a partnership with the limited liability of a corporation. An LLC member’s personal liability is normally limited to the amount of his or her investment. Under most states’ laws, the LLC structure is not available to licensed businesses such as law or accounting firms.
10
Q
Partnerships
A
- A partnership exists for tax purposes whenever a profit-motivated business is carried on by two or more people who share in income and expenses. As previously discussed, unless the partnership is an LLC, LLP, or limited partnership, partners are “jointly and severally” liable for partnership debts.
11
Q
Section 1202 Stock
A
- IRC 1202 allows individuals to exclude 50% to 100% of the
gain realized from the sale of qualified small business stock
held for more than 5 years.
12
Q
Family Holding Companies (FHC)
A
- Also sometimes called an asset holding company. It is a method of recapitalization.
- FHC is authorized to issue both voting preferred stock and non-voting common stock and is set up to manage the assets of another entity or entities.
13
Q
Buy-Sell Agreement
A
- an agreement between the
owners of a business, or among the owners of the business and the entity, to purchase and sell interests of the business at a price set under the agreement upon the occurrence of certain future events.
14
Q
Triggering Event of a Buy-Sell
A
- The events triggering a purchase may include the
death, retirement or disability of an owner, an attempted sale to a third party, and the termination of employment of an owner for reasons other than death, retirement or disability. Also divorce, bankruptcy or insolvency of an owner may also trigger an option or obligation to purchase.
15
Q
Cross Purchase Buy-Sell
A
21
Q
Tools for Business Transfer
A
