Creating a Win-Win During a Change in Control
by Darren Cooper
The sale of a company can increase its shareholders’ wealth and liquidity. However, shareholders may face a big tax bill after the sale. A well-timed gift of stock before the deal closes can reduce this liability. The shareholder will avoid paying capital gains tax on the donated shares and the entire amount of the gift is deductible for income tax purposes.
A non-profit organization needs the right information and the right strategy to benefit from these situations. Prospect researchers need to understand how to identify and communicate these opportunities. Only then can fundraisers select the right strategy to create a win-win for the non-profit and the donor.
Not all Deals are Created Equally
The details of a sale influence its tax consequences. The type of buyer and how the transaction is funded are usually the key variables. Here are some examples of what to keep in mind.
First, is the buyer paying with cash or with stock? All other things being equal, cash deals will lead to higher tax bills since the gain on directly held shares sold for cash will be subject to capital gains tax. Conversely, many all-stock deals are tax-free, while deals funded with cash and stock tend to fall in the middle.
Second, how are options (and other stock-based compensation) treated? When one public company buys another, target company employees usually have their options converted into equivalent options of the acquiring company with no tax consequences. However, when the buyer is private or a private equity firm, target company employees usually receive cash in exchange for their options and their gains will be taxable as ordinary income. The case study in this LinkedIn post is such an example.
Third, corporate inversions can lead to tax bills for shareholders of both companies. An example is the recent merger of Medtronic and Covidien, where Medtronic reincorporated in Ireland. In addition to the tax bills faced by Covidien shareholders, Medtronic shareholders exchanged their shares in the existing company for shares in the newly formed Medtronic plc. This exchange is subject to capital gains tax. Insiders also became liable for a separate 15% excise tax on their stock-based compensation when the deal closed. See this article and this article for more details on the transaction and the related controversy.
Finally, a few other factors come into play when assessing these opportunities. These include how long a company has been public; how much its share price has risen over time; and how widely held its stock is.
Strategy: Turning Information Into Solicitations
At the highest level, there are four major steps to take when planning strategy for these opportunities:
- Identify the pool of donors or prospects that likely own shares in the company or companies involved.
- Segment based on giving potential, the nature of the current relationship, and other factors (see below).
- For each segment, identify the best solicitation method and timing.
For each opportunity you identify, the prospect pool could include constituents who are current or former employees of the affected company or those who have previously donated its stock. Just remember that not every current or former employee will have stock and not every past stock donor will have more shares of the same company to give.
Prospect segmentation is generally straightforward, though the segments you select will rarely be mutually exclusive and each situation is likely to be unique. Examples of segments include:
- Constituents well connected to your non-profit versus those with a limited connection or no connection.
- Constituents with a large number of shares versus those with smaller and/or unknown amounts.
- Constituents who are relatively young versus those who are older (younger shareholders usually have fewer shares and/or less capital gains exposure).
- Constituents who have recently joined the company versus those who have been there longer (newer employees usually have fewer shares and/or less capital gains exposure).
- Constituents who are former employees that left after a short tenure versus those who left after a longer tenure and/or those who are retired from the company (longer-tenured former employees and retirees are more likely to still own shares).
- People motivated by tax benefits vs. those who are not (“tax motivated” donors can often be identified based on fundraiser input or look for people who usually give in December).
Solicitation methods should vary for each segment and/or specific prospect. Possible methods include:
- An in person solicitation.
- A personal phone call.
- A personal letter (likely from a fundraiser, but could be from a another key employee or board member, as appropriate).
- An impersonal letter (likely best for the prospects your organization is not well connected to).
- No solicitation at all.
Note that a solicitation could also be made as a follow-up to a recently made solicitation of an affected prospect, where the prospect is on the fence or undecided. Plus, multiple methods could be used in combination, such as sending a personal letter followed by a personal phone call.
Finally, there is the subject of timing. If you move too quickly you might ask a prospect for a gift to alleviate their tax concerns before they have figured out that taxes will be an issue. This makes your organization the bearer of bad news rather than the bearer of win-win solution. On the other hand, if you wait too long, then you will lose any “first-mover” advantage you might have versus other charities that might come calling.
For affected prospects that are already close to your organization, the best way to figure this out probably involves contact from a fundraiser, some open-ended questions, and lots of listening. For other prospects, I am less sure of the best way forward. I am not a fundraiser after all and solicitation timing is not one of my areas of expertise. Hopefully, someone can provide additional insights in the comments.
Finally, like I said in my LinkedIn post, even private company owners can benefit from a well-timed stock gift when their company is sold. The details are quite complicated and the pool of affected prospects could be a single person. But if the potential gift is large enough, working out the myriad details could be worth it.
About Guest Author, Darren Cooper
Darren Cooper is a prospect research and fundraising strategy consultant based in Rochester, Minnesota. Previously, he worked in higher education prospect research and supply chain software sales. Learn more at www.linkedin.com/in/darrenpcooper/ or contact him at email@example.com. Finally, none of the content in this post is intended to serve as tax or financial advice and should not be construed as such.
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About Guest Blogger
Darren Cooper is a prospect research and fundraising strategy consultant based in Rochester, Minnesota. Previously, he worked in higher education prospect research and supply chain software sales. Learn more at www.linkedin.com/in/darrenpcooper/ or contact him at firstname.lastname@example.org.