The ability of a minority owner in a closely held family business to obtain liquidity for her interest in the company is often very limited. There is not a great market to buy small holdings in such companies. There are also generally significant contractual restrictions on the ability of an owner to sell (such as absolute prohibitions on sale, rights of first offer, rights of first refusal, etc.).
Yet there are often important reasons why a minority owner might need liquidity. Also, an owner and the company may no longer see eye to eye. Having such an owner continue with the company could be disruptive to the effective workings of the business. As such, it is sometimes beneficial to all for that owner to have a way of exiting the business either in whole or part without undue disruption.
It is certainly possible to address these types of issues on a one off basis. However, a number of family businesses have established equity redemption programs so that there is some predictability regarding when and under what circumstances the company might provide liquidity. As with all things, there are a wide range of options but common elements of a plan include:
1. The extent of the commitment.
In general, the buyback is limited in dollar amount (for example, no more than $2 million per year) and might be limited as to individual owners (for example, absent approval of the board, no more than $500,000 per individual).
2. The method for determining value.
Often the value is determined by the board of directors on an annual basis, many times relying on an annual appraisal. In general, what is being valued is the per-share value, which often incorporates valuation discounting (such as lack of control and lack of marketability discounts). Valuation will also require setting the date for determination (for example, the value as of the end of the year or quarter).
3. Allocation of the opportunity.
If more owners want to sell than are funds available, the company needs to address how to allocate the redemption opportunity. One common way is pro rata.
4. Determining the process.
The plan will need to include details regarding when the owners must commit to sell, when the sale will close, what representations and assurance the owners are making and what else will need to be done to do to effect the closing.
5. Securities law considerations.
As in any transaction involving the purchase and sale of stock, there are a number of securities law implications for buyback plans. This includes the possibility that the buyback offer constitutes a “tender offer,” which would result in the need to comply with certain fairness rules. In the private-company context, the best approach is to assure that the offer remains open for a predetermined period before closing (most commonly 30 days or more), and that no securities are repurchased nor any cutback limits imposed until the expiry of that waiting period. Additionally, companies should attempt to assure that all tendering holders receive an equivalent value (almost always in the form of an identical price) for the securities they tender in response to the proposal. Also, because the company is a participant, it often will have information not available to unaffiliated stockholders. Consideration should be made regarding the information to be provided and the sophistication of the sellers (including the possible need for a financial advisor for unsophisticated shareholders).
As an alternative to an annual buyback plan, companies sometimes adopt a one time or limited buyback program. The same issues outlined above would need to be considered in a onetime plan.