The Power of the Partial Exit: Reducing Capital Gains Tax While Keeping a Seat at the Table

For many business owners, leaving the business they built over the years can be a difficult decision. For some, they want to gain near-term financial rewards while still staying involved in some sort of capacity while planning the next chapter in their life. This is where a partial exit or “recap” of their existing business can provide the best of multiple worlds.

Perhaps you have been approached by a private equity firm that wants to buy your company. You don’t have to sell it in its entirety. In the US each year, approximately 8000 to 10,000 companies have engaged in transactions in which a business owner will sell a majority stake in the business (55-60%)  and retain a significant minority share(40-45%). This partial exit or recapitalization (“recap”) has grown in popularity. This initial sale is sometimes referred to as the “first bite of the apple”, allowing the business owner to enjoy a wealth infusion before they may sell the remainder of their company at some future date.

Doing this allows the business owner to gain an immediate financial windfall. Unfortunately, a sizable capital gains tax hit will also occur. Your massive check may crash headfirst into a massive tax bill.

However, if structured properly, a business owner can enjoy a new source of wealth, avoid the bite of the capital gains tax, retain some level of involvement in their business, and take time to decide what their future may look like. Charitable giving can be the linchpin that brings all of these benefits together.

This article will provide the initial guidance on how to do this best.

The problems when business wealth and tax impact collide

Charitable Giving as a Tax Strategy

You can use a charitable giving vehicle(such as a donor advised fund {DAF} or charitable remainder trust{CRT}) to donate a portion of your partial exit proceeds into before your sale.

There is a double tax benefit in doing this:

• Eliminate Capital Gains: You pay $0 in capital gains tax on the value of the business shares that transfer into the charitable vehicle.

• Fair Market Value Deduction: You gain an immediate tax deduction for the full market value of the shares you gift, which can help offset the taxes owed on the shares that you did sell for cash.

A key detail is that the DAF or CRT must exist prior to binding obligation to sell the business is reached, with the relevant proceeds going directly into the DAF or CRT at the time of the sale. Receiving those cash proceeds first without direct transfer eliminates the tax advantages you are trying to pursue.

The Sales Scenario: The “Recap” Math

Let’s review two examples:

Scenario A: A company founder sells 60% of a company valued at $20 million to a PE firm. They receive $12 million in cash but pay $3 million in taxes.

Scenario B: A company founder sells 50% of a company valued at $20 million to a PE firm but gifts an additional 10% at the time of sale into a DAF. They receive $10 million in cash, but the $2 million gift creates a tax deduction that likely wipes out much of the tax bill on the $10 million. The $2 million gift allows them to engage in charitable giving on into the future to support causes important to them.

In the scenarios above, the founder in Scenario B may have less initial personal cash, but have a $2 million “bank account” to give to favorite causes, and paid much less to the IRS than the founder in Scenario A.

The Next Bite(s) of the Apple

If we borrow from the scenarios above, the partial exit allows the following:

• Growth: You still own a percentage of the company.  As the PE firm grows the value of the business, your percentage grows as well.

• Repeat the Sale: As the minority owner, you can sell a percentage of the company again in the future, allowing you to get another “bite of the apple” and complete the process again.

• Legacy: This transition gives you the space to explore your next chapter and decide if turning your hard-earned success into a lasting charitable legacy is the meaningful 'next act' you’ve been looking for.

Conclusion

A partial exit does not mean you have to settle for a partial tax strategy. By planning ahead and understanding the variety of options available to you, you can build a selling & tax plan that makes the best sense for your interests. At Generosity Nexus, we have the experience and track record to help you determine your best options.

Don’t hesitate to schedule an appointment to learn more about how we can help you.