I have become fond of dividends[1] in
recent years especially with the advent of the current 15% federal income tax
rate on “qualifying
dividends.” For owners of
closely-held businesses, however, the subject of paying dividends continues to
be fraught with tax and legal issues depending on your organizational structure
(“C” corporation, “S” corporation, LLC, etc.) and the state(s) within which the
business operates.[2]
Here are some examples of situations where paying a dividend was the right way to “monetize” the owners’ equity:
- A third generation manufacturing company – A few members of the family worked in and ran the business while other family members became passive shareholders. To keep peace and balance the interests of different family members, the company paid good salaries, but modest bonuses, to the managers along with healthy dividends to all the shareholders.
- A growing company in need of capital – The owners sold to a public company with a large capital base to support its operations. Because the business had been very profitable, part of the “purchase price” was a sizeable dividend of previously taxed income[3] which in turn was not subject to capital gains taxes.
- An IPO[4] without selling shareholders – Often, investors and investment bankers prefer not to have current owners sell shares directly in an IPO – it raises questions about the current owners’ confidence in the business. The owners of one large IPO company achieved significant liquidity without selling shares by paying out all of the company’s retained earnings as a dividend immediately before the closing of the offering.[5] The dividend was financed through a note which was then repaid from the proceeds of the offering.
Used creatively, paying a dividend can be a real winner.
[1] This is
the first in a series of articles illustrating different ways to “monetize your
equity.”
[2] This
article is intended for informational purposes only and does not represent tax,
accounting or other professional advice. Please consult your own tax and other
professional advisors before taking action based on the information presented
herein.
[3] The
business had been operated as an “S” corporation and therefore its shareholders
were not subject to double taxation on the dividend because it was “previously
taxed income.”
[4] Initial
public offering
[5] See note 3.
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