THE WAITING IS THE HARDEST PART
4 KEYS TO GETTING CAPITAL PROVIDERS TO BUY IN TO YOUR BUY AND BUILD THESIS
FEATURED BUSINESS LEADER
Reginald Binford, Jr.
DIRECT INVESTING BY FAMILY OFFICES
EQUITY ROLLOVERS IN CONNECTION WITH THE SALE OF A BUSINESS
EARNOUT SPOTLIGHT
Douglas Hirsch, Esq. Partner at Sadis & Goldberg
MASTERING NETWORKING EVENTS
The Top 5 Keys to Success From a Conference Producer
By Paul Marino
By Drew Brantley
By Yehuda Braunstein
By Seth Lebowitz
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By Roger Kowalski
BY PAUL MARINO
As we walk the back nine of 2024 (and from the play on the front nine, the 19th hole cannot come fast enough), there are a few things that are certain at this time:
(i) rate cuts have not happened (as of August 8, 2024), even though most economists thought we would have had a 150 bps reduction in the terminal rate (R*) by the end of Q2 (and unless there is a full meltdown in the economy, I do not see rate cuts of more than 25 bps per quarter will happen this close to a presidential election—in fact (not to play conspiracy theory guy), if a significant rate cut happens and Trump is elected, every member of the Federal Reserve (the “Fed”) will be searching for a new job, while if Harris is elected, every member of the Fed will have to explain why rate cuts weren’t more than 25 bps per quarter);
(ii) inflation has not been transitory (even if CPI print comes in at less than 3 percent);
(iii) the M&A environment has not recovered (most pundits believed that 2024 would be a great year for M&A, but that has not transpired… more on that below); and
(iv) anything connected to artificial intelligence (“AI”) carries with it an equity/enterprise multiple last seen when Netscape1 was waging a war on Microsoft for internet browser domination.
As many of my peers in the middle-market M&A space can attest, the deal flurry that once looked so promising heading into 2024 has stalled to a crawl. While there have been a number of large deals announced thus far in 2024, the middle market remains mostly unchanged from 2023. Some pundits and colleagues attribute the lack of activity to higher interest rates, others attribute it to the mismatch of the bidask spreads between buyers and sellers (i.e., valuation), and yet others say it is because the fundraising environment is generally poor.
Admittedly, it is likely all of the above; however, in the end (at least until AI takes control of every aspect of our lives), it is sentiment that controls how we react, interact and transact. For example, a great question that is asked and answered by corresponding data collected is Direction of the Country (Wrong Track/Right Direction). As of August 8, 2024, polling has indicated that 67% of people believe the country is headed on the wrong track, more then 2/3rds of people polled—
that is meaningful.2
Sellers do not transact if they believe the market is at the bottom for one simple reason—it’s anathema to capitalism (even in a Bizzaro World, no one looks to buy high and sell low). Simply put, there is a disconnect between the bid-ask spread between seller and buyer. Buyers do not transact if they believe the market (i.e., valuation) has more room to fall; in other words, no one wants to catch a falling knife, and, clearly, buyers believe that sellers need a mental valuation correction.
If one “buys” the sentiment theory, then the next question is: How does sentiment turn positive?
Admittedly, if I really knew the answer to the foregoing I’d be a very wealthy man. The answer is likely similar to (and directionally different from)
Hemmingway’s quip on bankruptcy in the “Sun Also Rises:”
“How did you go bankrupt?” Bill asked. “Two ways,” Mike Campbell said. “Gradually and then suddenly.”
“What brought it on?”
“Friends,” said Mike. “I had a lot of friends. False friends. Then I had creditors, too. Probably had more creditors than anybody in England.”
How do you tell when sentiment is moving in a positive direction? Two ways: first, friends/peers are talking about doing deals, traveling to look at deals and asking you about deals, and talking about missing out on deals; second, banks and private credit funds are accommodative. If/when banks (both commercial bank or “non-bank” banks) are competing over your transaction and lowering the barriers to enter into a loan (e.g., by lowering the
LTV, agreeing to covenant-light terms, finalizing and issuing a term sheet within hours rather than days or weeks), then sentiment is moving in a positive direction.
To wit, I have not seen much of any of the foregoing; however, with the number of private credit funds now looking at deals, competition to lend may heat up.
The billion-dollar question is: Will rates start falling, and if so, when? And once rates do start falling, will the cost of capital for borrowers decrease, or will lenders keep rates close to where rates are now?
The equity market is addicted to a “5-card Monte”/ parlor game that generally predicts whether rates will increase, decrease, or remain the same. The government loves this “addiction” because it puts its policies front and center of everything, including controlling the animal spirits that power our economic capitalistic engine. It is a mutual codependence. Let’s be clear: the government (left/ right/center/Democrat/Republican/Libertarian, etc.) loves being the most important thing in your life because…well, it is the most important thing in your life (like every organism, the federal government—heck any government wants to exist and be relevant).
Since 1977, the Fed has adhered to three (3) key mandates: (i) to effectively promote the goals of maximum employment; (ii) to stabilize prices and to moderate long-term interest rates (what is now commonly referred to as the Fed’s “dual mandate3” even though there are three components. For our purposes we are going to break up the last leg of
the dual mandate into two separate components).
Thinking about the dual mandate, it would appear that the Fed has some wood to choose as it relates to two of its three main purposes. Can you guess which ones? I will give you a hint: the second largest population cohort in the modern history of the USA (the Baby Boomers, which were the largest, until the Millennials came around) is almost fully retired, while the smallest cohort (i.e., Gen X) is filling the upper management gap. However, the number of Gen Xers is not nearly big enough to fill the gap left open by the Baby Boomers, and the Millennials are not yet ready to fill those positions. The foregoing will result in labor shortages or tight labor markets for (likely) the next 10-15 years—and that is hoping that the Millennials even form “traditional” homes and/or have children. Accordingly, while there could be job loss (and indications from the May jobs report appear to support this), long-term structural unemployment does not seem to be an issue for the U.S. economy—unless of course AI teams up with robotics and we are all replaced by the T-1000 or Uniblab (email me if you know the reference and yo’ll get a shout out in the next Earnout).
Here are some other relevant stats (courtesy of Clinton Investments5):
• The U.S. Real GDP growth has declined materially, falling by over ~67% since the third quarter of last year.
• U.S. households are now carrying the highest levels of housing and non-housing debt in a generation.
• The impact of diminished consumer spending can be seen in the meaningful slowing in retail sales over the past few months.
• The ~408,000 jobs that were lost, according to the May household survey, could be a harbinger of what the U.S. economy is likely to face going forward.
• COVID savings have been spent (look at Disney’s earnings call and the fact that its parks were flat to negative).
The foregoing signals that a rate cut (or cuts) may be around the corner. The only question is: Will they be too late or too early? Why too early?
Because you can look at what happened in the mid-to-late 1970s, when Chairman Burns cut rates only to see inflation increase shortly thereafter. He followed that with a rate increase only to throw the economy into a recession. This cycle continued until Chairman Volcker famously raised rates to 20% in December of 1980 (to combat 14.6% inflation), which started lowering a process to 1314% in 1982 and 10.2% in 1984. From thereafter, rates have generally continued to decrease, until
The other two mandates (i.e., the dual mandates) of stable prices and moderate long-term interest rates are more difficult because: (i) pricing dynamic is a complex indicator but is generally driven by demand and scarcity—both of which are greatly affected by consumer wealth (e.g., I have extra money and I want that new car) and scarcity (e.g., think back to the cabbage patch kids of the 1980s); and (ii) moderate long-term rates are not easy to achieve—in fact, good luck with that due to the record debt-to-GDP ratio, cash spent on entitlement programs, and helicopter money pushed by the government’s and the Fed’s monetary policy (thank you, Milton Friedman).4
the recent 500 bps increase that occurred over the last approximately three (3) years.
Too late means that the country goes into a recession; and a recession (deep or shallow) would likely do very little for the Fed’s employment mandate—likely not much because the labor market (due to demographics) will remain tight. It will not help our national debt (which will become a bigger problem as it compounds), but it will (likely) squash inflation and stabilize pricing (and maybe even bring down the price of a bag of Doritos or Hershey’s bar).
What does all this mean? It means that no man wants to be remembered as the Chairman who could not tame inflation (i.e., Chairman Burns)— and every man wants to be known as the hero of the economy (i.e., Volcker).6 In short, rates dropping 200-300 bps is unrealistic; instead, we can expect to look for a token 25-50 bps decrease; which won’t do much for the economy, but may indicate that there is hope on the horizon. That positive anticipation might just be good enough to begin moving sentiment (the same sentiment we talked about above) in a positive direction—after all, don’t we all have a little Lloyd Christmas in us, “So you’re telling me there’s a chance?”
What does this mean for deals? Not much. Until: (a) LPs determine that they will get their money back within a set period of time (this elongated return cycle has led many investors—especially family offices to be wary of pooled investment vehicles—and the need for duration certainty and liquidity has increased the popularity of secondary investments (more on that later on in the Earnout); (b) sponsors believe they are not catching the falling valuation knife; and (c) sellers feel that they are not selling into a slide (and remember: when there is FOMO (as the kids call it these days), people rush to transact; and when there is no FOMO, no one rushes to transact—essentially, why rush if there is no line?).
Like Rocky Balboa said, “If you want to dance, you’ve got to pay the band; if you want to borrow, you’ve got to pay the man.” The question then becomes: When are we going to dance again, and how much are we willing to pay the man?
1 For those who do not remember Netscape (a/k/a Mosaic Communications Corp.): https://en.wikipedia.org/wiki/Netscape 2 https://www.realclearpolling.com/polls/state-of-the-union/direction-of-country 3 eb_11-12https://www.richmondfed.org/publications/research/economic_brief/2011/ “The idea that the Fed should pursue multiple goals can be traced back to at least the 1940s; however, with shifting emphasis on which objective should be paramount. That such a mandate may, at times, create tensions for monetary policy has long been recognized as well.”
4 https://www.investopedia.com/terms/h/helicopter-drop.asp 5 moderation/https://www.clintoninvestment.com/cim-market-commentary-cue-the-great-
6 Remember, inflation is a monetary phenomenon caused by an increase in monetary supply that outpaces economic growth. (Thank you, Milton Friedman.)
PAUL MARINO Partner
Sadis & Goldberg
pmarino@sadis.com
Paul Marino is a partner in the Financial Services and Corporate Groups. Paul focuses his practice in matters concerning financial services, corporate law and corporate finance. Paul provides counsel in the areas of private equity funds and mergers and acquisitions for private equity firms and public and private companies and private equity fund and hedge fund formation.
BY DREW BRANTLEY Managing Director Frisch Capital Partners
Whether it was the Rockefellers, General Electric, or KKR, buy and builds (or roll ups), have been a core part of a successful playbook for over decades. It is still a core part of many Independent Sponsor, Private Equity or Family Offices theses. At Frisch Capital, approximately 80% of our Independent Sponsor deals have acquisitions as a core part of their thesis. While it takes a lot of work to buy and integrate multiple businesses, it can help you achieve scale faster than organic growth. When done right, buy and builds can create incredible returns at exit.
If buy and builds are so popular, then why can it be difficult to get capital providers to buy into your thesis? How can you stand out from the many other Independent Sponsors pitching their own buy and build thesis? Through the years, Frisch Capital has helped raise well over $1.5 billion dollars of capital for Independent Sponsor deals and many of those were buy and builds. We have distilled down four key things that you need to have in place (or be the process of doing) to give yourself the greatest chance of success getting capital providers to buy in early on.
While you can start with a small or big company out of the gate, capital providers often like to be able to call one of the companies a platform. Often, this company has some size or scale compared to other companies your pipeline. It might have great leadership in place or bench strength that can be used to grow. Maybe it has better systems or processes, or a better “mouse trap” than the competition. But at the end of the day there is often a company that stands out from the others. It is important to note, it does not need to be a perfect platform with everything in place. Most lower middle market companies are not perfect. Therein lies the opportunity for Independent Sponsors and their capital partners. But the key is to have some of the things listed above in place that help make one company you are acquiring better than the others.
Today, if a company is of scale ($4 million of EBITDA or higher) they are often bombarded by potential investment bankers or advisors telling them what their company is worth and that they will be happy to help sell it for them and get top dollar. The
challenge for Independent Sponsors is sometimes competing in these more robust processes. Therefore many seek to move down market where there is less competition. It becomes a fine balance trying to find a company that has the makings of a platform, without getting too small. We have done deals where the platform company was as small as $1.5-3 million of EBITDA. The key is not the size necessarily, but the potential that is found within the company as discussed above. The proverbial “diamond in the rough”. While many people do not think that a company that is between $1.5-3 million of EBITDA is a perfect platform, many great buy and builds start with a platform around this size.
While this might seem logical, many Independent Sponsors put off building an active pipeline of acquisitions with the idea that once they get the first deal done, then they will focus on other acquisitions. While you can do this, there are two main issues with this when trying to get capital providers to buy into your deal.
The first issue is that if your platform is subscale (less than $4 million of EBITDA) then you can have a hard time getting capital providers to engage based on size alone. While many capital providers have $2-10 million of EBITDA listed on their website as their investment range, many prefer to start closer to $5 million of EBITDA out of the gate. This means if your platform is $2.5 million of EBITDA, you will likely need another company or two under LOI, or very close to LOI, at the same time to get capital providers interested in the deal. While this can be difficult and take a lot of time, we see it done often very successfully. We recently worked on a deal where a capital provider told us, “The Independent Sponsor showed us this deal a few months ago and we passed on size alone. We liked them and the thesis, but it was too small”. We, Frisch Capital, worked with the Independent Sponsor to get a second company under LOI and that same capital provider later proposed and was ready to be their capital partner for the deal. Without the second company under LOI, they would not even consider the deal or thesis. In another Independent Sponsor deal, something was uncovered during due diligence related to the platform company resulting
in the Independent Sponsor and the capital provider dropping the platform company from the deal. Because they had an active acquisition pipeline, we were able to pivot to another company and replace the platform.
The second issue with not having an active pipeline is getting capital providers to believe that you are capable of a buy and build. Having an active pipeline with more than one company under LOI and multiple active conversations with other companies easily solves this concern and takes it off the table.
It goes without saying that a highly fragmented industry is preferrable and building an active pipeline takes time and patience. We have seen an active acquisition pipeline alone save deals that would have otherwise never gotten closed.
Many sellers want to sell because they are ready to transition out of the business. While many say they are willing to stay on for a “transition period of 12-18 months”, we have often seen where the second the deal closes, a seller mentally checks out and is no
longer mentally engaged in operating the business. A company without a committed and focused CEO creates a ton of risk for an Independent Sponsor and their capital partners. Who the day-to-day CEO is going to be post-close is arguably one of, if not, the most important things in a deal. For this reason alone, if the original seller is not going to be dedicated to being the CEO for the next 3+ years, most capital providers want to know who the new leader will be before closing. Many Independent Sponsors want to rely on the seller to be the CEO at close and then suggest finding a replacement during the 12-month transition period post-close. While you can do this, most capital providers view this as risky.
Independent Sponsors often partner with someone who will step in as the CEO, hire a recruiting firm to find a CEO, or work with their capital partner to find one together. Regardless, we have found this to be a very critical, if not the most critical aspect of getting capital providers to buy into an Independent Sponsors buy and build thesis.
We all know that getting the deal closed is step one, but your plan and actions post-closing is
what will produce the returns you want. Having a plan to integrate companies can involve many parts including, system, processes, geography, equipment, and not least of all… the people. There are many stories of buy and builds that did not work because there was not a thoughtful plan to integrate and execute post-closing. You can and should expect your plan to evolve, but having a good detailed plan is step one.
Importantly, you need more than just an outline of a plan. You must be able to talk capital providers through your understanding of “what we have in place at close”, what is missing, and how are you thinking about filling in the missing personnel and infrastructure of the business. You do not have to have it totally figured out and capital providers often bring additional experience, perspective and value to enhance your thesis, but it should be you starting the conversation having put pen to paper on the topic.
While these four areas are by no means exhaustive of everything it takes to get capital providers to buy into your thesis and deal, focusing on these four areas ahead of time will put you ahead of your competition. It will demonstrate to capital providers the value-add you are bringing to the deal.
DREW BRANTLEY Managing Director Frisch Capital Partners
Drew is a serial entrepreneur having started 5 businesses, sold a few and still owns some. He knows what it’s like to be in your shoes. He sees the Independent Sponsor model as the method executives and industry experts can take to own and run already established businesses. He now dedicates his career to helping individuals buy companies, find greater success and live life on their own terms.
For 28 years, Frisch Capital Partners has specialized in raising equity and debt for value-added Independent Sponsor transactions.
Over $1.5 Billion of Capital Raised
$3 Million -$40 Million
Reggie Binford’s career in private equity exemplifies his ability to balance professional growth with personal responsibilities. Early in his career, he quickly transitioned into the private equity world, where he honed a strategic approach driven by a mix of real-world experience and insights from industry leaders. His exposure to key influencers in the field helped shape a practical, resultsoriented mindset that has guided his journey.
Throughout his career, Binford has been recognized for his leadership style, which combines hands-on involvement with a long-term vision. As a dedicated father and husband, Binford often draws parallels between raising a family and guiding a company, understanding the importance of dedication, nurturing, and the foresight required to achieve sustainable success. His ability to balance these personal and professional aspects has earned him respect in both arenas.
Binford’s professional approach centers on value creation, ensuring that the companies in his portfolio are set up for long-term growth. He is
known for his focus on resilience and adaptability, two qualities that he believes are critical in today’s evolving financial landscape. As a result, Binford remains a forward-thinking leader who is not just focused on short-term gains but also on building a lasting legacy within the private equity industry.
In addition to his strategic acumen, Binford is deeply committed to mentoring the next generation of professionals in private equity. His leadership extends beyond his portfolio, as he actively fosters growth and development among up-and-coming talent. Binford’s approach emphasizes resilience, adaptability, and the importance of fostering relationships—both in business and in life—that stand the test of time.
For a deeper dive into Reggie Binford’s journey and insights, watch the full interview.
BY YEHUDA BRAUNSTEIN
Family offices continue to play a prominent role as lead investors in the alternative investment industry. As family offices continue to become more sophisticated, they are seeking new avenues to expand and diversify their changing investment portfolios. One investment model that has recently picked up momentum is the strategy of investing directly in a private company, rather than investing in companies through a private investment fund, also known as direct investing. According to a 2023 report by FINTRX,1 approximately 69% of single-family offices have made direct investments as part of their investment portfolio.
In general, direct investing enables family offices to have greater control over their investments including controlling entry and exit points. Additionally, direct investing gives family offices the opportunity to utilize their expertise to assess specific industries and investments to make decisions that can help increase the value of their investments, all while avoiding fees typically associated with investments managed by third-party investment fund managers.
This article will (1) discuss the benefits of direct investing by family offices, (2) analyze some of the costs and concerns that need to be accounted for when engaging in direct investing, and (3) suggest another
investment option available to family offices, namely co-investing, which provides many of the benefits of direct investing, while also mitigating some of the costs and concerns.
The key motivating factor for family offices to engage in direct investing is their ability to have more control over their investments. Specifically, they can seek to structure the investment terms, negotiate deal points, and/or dictate entry and exit points. This can only be done by family offices that have specialized knowledge in a sector, giving them a leg up in structuring, managing and monitoring their investments. Industry knowledge
can motivate family offices to make their own investment decisions, which has led family offices to become “players” within various industries.
Moreover, many family offices are not only willing to make direct investments, but are also finding themselves in controlling positions with respect to their investments. In fact, according to a 2023 family office report from William Blair, 37% of family offices have taken a controlling position in their direct investments, with the average investment size being $17.6 million.2
Some additional benefits of direct investing are that it allows family offices to avoid (1) fees and (2) “lack of visibility” issues typically existing when investing through a fund, as further explained herein.
Typically, a private fund will require a family office to pay management fees and/or carried interest as part of the family office’s investment in such fund. Furthermore, a family office will be subject to the private fund’s own timeline for the deployment and harvesting of capital, rather than controlling the entry and exit points itself. In contrast, a direct investment strategy: (i) would allow a family office to avoid the foregoing fees and (ii) would also give it room to create its own timeline based on its internal expectations, rather than relying on, or being subject to, the whims of a third-party fund manager.
Although direct investing can potentially provide
many advantages to family offices, implementing the strategy is usually a substantial task for family offices and requires a sophisticated understanding of the industry applicable to their target investments. Family offices need to be capable of addressing everything required in the direct investing process, including: (x) understanding investment and operational risk, (y) appreciating the importance of conducting due diligence and being able to execute due diligence review, and (z) if necessary, integrating an outside team for assistance.
While direct investing generally leads to better control over investments, such control comes at a
cost. Direct control often requires significant work and time from the family office, and, as discussed below, at times, the engagement of an internal or external team that can assist with the task. While charges of third-party management fees and carried interest can be avoided, the operational risk associated with any potential missteps makes direct investing a high-risk/high-reward strategy. In order to capitalize on the expense-saving, family offices need to be experienced in the relevant industry or sector so that they have a thorough understanding of the risks associated with their target investment.
The considerable expenditure of time and cost of due diligence led 66% of family offices to tell William Blair that it is a challenging legal aspect of direct investment, by far the highest response rate among other issues.3 A comprehensive due diligence process requires market analysis, an understanding of the industry competition, and a financial analysis of the potential investment. While the due diligence process may seem daunting and costly, identifying any underlying issues during due diligence is critical in order to mitigate operational risks and reduce future costs, and possibly provide a stronger negotiating position than would otherwise be possible. Additionally, because direct investing will require continued hands-on monitoring, family offices should ensure that their due diligence process provides for a significant operational review, and not just initial investment due diligence.
Ideally, a family office can rely on its experience in the relevant industry sector, allowing it to create an
internal team that can (x) tackle the tasks associated with making a direct investment and (y) give the family office direct oversight while reducing outside costs. A family office should first look at its current structure to determine which industries and which parts of the investment process can be leveraged by its existing skillset, thereby empowering it to focus on investments in its “sweet spot” from the start.
There may be times when the experience or size of a family office may be insufficient to take on the challenges of making a direct investment. In order to better appreciate investment opportunities and depending on the size and experience of a particular family office, such family office may benefit from utilizing outside resources that can take on some of the due diligence burden and other operational aspects of the direct investment process. While developing an outside team can be time-consuming and costly early on in the process, the additional resources should allow the family office to focus on its strengths while maintaining a complete investment strategy. Further, combining an outside resource with a sophisticated internal team may be a key step in expanding the reach and success of a family office.
One way to mitigate the cost of direct investing and to potentially share risk with other parties is to engage in co-investing with other family offices, other funds, or independent sponsors. In general, co-investing opens the door to a larger capital pool and possibly to an increased knowledge base in additional sectors that may not be already accessible
to a family office. According to William Blair’s family office survey, more than 65% of single-family offices have partnered in co-investments with other family offices.4 By developing relationships with other family offices, a co-investment strategy may offer a wider range of potential investment industries and additional investment opportunities.
Once a direct investment has been identified, the combined resources of multiple investors in a co-investment vehicle may result in a more comprehensive analysis prior to the consummation of a transaction, thereby giving a family office a clearer picture of what it may be encountering. This team effort may also provide more clout in negotiating entry and exit opportunities, thereby potentially providing stronger returns in both the short and long term. In addition to increased opportunities and sharing in potentially higher returns, family offices engaged in co-investments may also share overhead costs, thereby further reducing expenses.
Co-investments are also popular between family offices and independent sponsors. In these types of arrangements, independent sponsors find target companies and/or investments first, and then seek capital. The independent sponsor model gives family offices the ability to opt in or opt out of ventures on a deal-by-deal basis. This flexibility provides family offices with both (x) the perks of direct investment and (y) the deal-finding skills of independent sponsors, all while reducing the costs and potential risks associated with direct investment.
As direct investing becomes a more attractive investment strategy for family offices, the individuals and teams engaged in this strategy should be cognizant of the risks and benefits associated with their investments. If you have any questions about this article, please contact Yehuda Braunstein at 212.573.8029 or via email at ybraunstein@sadis.com.
YEHUDA BRAUNSTEIN
Yehuda M. Braunstein heads up the Family Office practice and is also a member of the firm’s Financial Services and Corporate groups. Yehuda counsels family office clients in connection with all aspects of their operations, including formation issues, governance and compensation issues, strategic planning, joint ventures, coinvestments, transactional and day to day matters as well as compliance issues.
BY SETH LEBOWITZ
An equity rollover (that is, a transfer by a seller of some or all of the seller’s interest in a business being sold in exchange for a direct or indirect post-sale interest in that business) can play a useful role in structuring a sale. In some cases, a buyer may want one or more owners, such as a founder or other key manager, to stay on board with an incentive to facilitate the business’s post-sale success. At times, a seller may wish to own an equity interest in an enterprise with attractive growth potential. A purchaser may also want to limit the cash required to purchase the business, or a seller may hope to reduce the tax liability from gain on the sale (as discussed below).
Whatever the motivations in a given case, sellers should consider income tax implications when contemplating an equity rollover as part of the sale of a business.
In a given situation, the form of an equity rollover intended to be tax-advantageous to a seller depends on factors such as the nature of the acquiring entity and the entity being acquired, the parties’ goals, and the details of their business deal. For example, whether each of the acquirer and the acquired entity is treated for tax purposes as a corporation or a partnership, the parties’ expectations about control and the seller’s participation in management, and whether the acquirer expects a full (i.e., in the
full dollar amount of the value the acquirer assigns to the purchased business) basis stepup in the acquired assets can all play a role. This article highlights several federal income tax1 issues for sellers and illustrates the importance of considering whether to implement an equity rollover and the tax implications thereof. Although each specific situation needs to be analyzed in light of its specific facts, the general principles outlined herein have broad application to many different combinations of factors that motivate sellers and buyers. In the discussions below, the background facts assumed, unless otherwise specifically noted, are that one or more sellers own an operating business organized as an LLC2 and a sale to a third-party buyer is being negotiated. It is also assumed that a cash sale of the business would produce a taxable gain for each seller.3
In an equity rollover in connection with the sale of a business, a seller usually utilizes at least one of two “nonrecognition” provisions of the Internal Revenue Code4: Section 721, relevant to transfers to partnerships, and Section 351, relevant to transfers to “controlled” corporations. This control requirement, discussed below, makes Section 351 less flexible than Section 721, although structuring an acquisition so that the required control will exist is often possible if other considerations allow sufficient flexibility.
Section 721 provides that no gain or loss is recognized by a partnership or its partners upon a contribution of property to the partnership in exchange for an interest in the partnership. Therefore, if the requirements of Section 721 are met, a contribution of appreciated property to a partnership in exchange for a partnership interest does not result in immediate taxable gain to the contributing partner. A simple example illustrates the operation of Section 721 to achieve nonrecognition for the portion of a seller’s equity “rolled over” into the acquirer. An LLC, owned 90% by its founder and 10% collectively by several other owners who are not candidates for an equity rollover, is to be acquired by a partnership such as a private equity fund,⁵ and the value of the LLC’s entire business is $10 million. The founder’s tax basis for the 90% LLC interest is $500 thousand. If the partnership purchased the founder’s entire interest in the LLC for $9 million in cash,⁶ the founder would recognize $8.5 million of taxable
A proposal by a buyer (sometimes referred to as a “rollover,” although it is not the kind of rollover that this article focuses on) that a seller reinvest some sale proceeds into an acquiring (or related) entity should be carefully vetted, because although implementation of such a proposal may result in an ownership structure similar to the rollovers described below, such an arrangement would likely be treated as a taxable sale in its entirety followed by an investment of some of the cash proceeds. That is, a seller could agree to a “rollover” that results in full taxation, but without full use of the cash proceeds. Some sellers might make the choice to do so, but such a choice should be based on knowledge of the proposed method of acquisition and its tax impact on the seller.
gain ($9 million minus $500 thousand tax basis) on the sale of the 90% interest. If, alternatively, the partnership paid $7.65 million cash for 85% of the founder’s 90% interest and issued a partnership interest valued at $1.35 million for the other 15%, then the founder would recognize $7.225 million of taxable gain ($7.65 million, representing 85% of $9 million, minus $425 thousand, representing 85% of the founder’s tax basis) on the cash sale, and would not recognize gain for tax purposes on receipt of the partnership interest. The founder would recognize $1.275 million less in taxable gain as compared with a cash-only sale (even if such sale is followed by re-investment of proceeds). This unrecognized gain would be preserved in the tax basis of the partnership interest received, although it potentially can be deferred until disposition of the interest, and depending on future events it is possible that the deferred gain will never be subject to income tax.7
Section 351 provides that no gain or loss is recognized by a transferor upon a transfer of property to a corporation by one or more persons solely in exchange for stock8 in such corporation if immediately after the exchange such person or persons are in “control” of the corporation. Control of a corporation for this purpose is generally defined as ownership of at least 80% of the voting power of all voting stock of the corporation and at least 80% of the number of shares of each class of non-voting stock.
Because Section 351, unlike Section 721, includes a “control” requirement, a combined sale and contribution transaction with a corporate acquirer analogous to the example above utilizing a partnership acquirer would not allow for nonrecognition of gain by the founder unless the founder, together with any other contemporaneous transferors of property in exchange for stock, are in control of the corporation immediately posttransfer. Frequently, an acquirer is too large, or an interest to be rolled over is too small, for the required control to exist. However, alternative methods may achieve a similar result for the founder even in the case of a corporate acquirer.
For example, the acquiring corporation might purchase 85% of the founder’s 90% LLC interest for $7.65 million in cash and then contribute that LLC interest, together with the interests purchased from other owners, to a newly-formed corporation in exchange for stock. The founder would contribute the remaining 15% of the 90% LLC interest to the new corporation in exchange for stock. The founder would, as in the partnership example above, recognize $7.225 million of gain on the cash sale. Since the corporate acquirer, together with the founder, would collectively own all of the new corporation’s stock, they would be treated as being in “control” of the new corporation immediately post-transfer, and the founder’s transfer could qualify for nonrecognition of gain under Section 351. As in the partnership example above, the founder would recognize $1.275 million less in taxable gain in comparison with a cash-only sale (even if such sale is followed by a re-investment of a portion of the proceeds). This unrecognized gain would be preserved in the founder’s tax basis in the stock received, although it potentially can be deferred until disposition of the stock, and depending on future events it is possible that this gain will never be subject to income tax.
At times, a seller may be able to accomplish a result that is similar, in terms of nonrecognition of gain, to an equity rollover under Section 721 or Section 351, without relying on either provision. If, for example, the seller sells part of the LLC interest for cash and simply retains the remainder, the cash sale would produce taxable gain, whereas merely retaining an LLC interest one already owns is ordinarily not a taxable event. This method is simple from a structuring standpoint, but frequently does not fit with the parties’ other plans (for example, if
the acquired business will be integrated into the business of an acquiring entity).
Use of Section 721 or Section 351 (or a combination) to facilitate qualification of a rollover for nonrecognition treatment frequently will be dependent on factors such as whether (and in what form) the acquiring entity already exists, whether (and at what time) the acquired business will be combined with other businesses, and plans for a future sale of the acquired business. If the
parties are able to reach agreement on these and similar issues, a significant amount of flexibility exists for planning an equity rollover into either a partnership or a corporation in connection with the sale of a business. This flexibility can at times involve creation of additional partnerships or corporations and sequential transactions intended to qualify for nonrecognition of gain. These principles may be applied to multiple
sellers, as well as to some, but not all, of the sellers in a transaction. And they may be applied, with important nuanced differences in result, to the sale of a business treated for tax purposes as a corporation, a partnership or a disregarded entity. As always, it is worthwhile to seek input from a tax attorney along with that of corporate attorneys when negotiating and documenting the sale of a business.
1 State tax treatment often, though not always, follows the federal tax treatment of these transactions. It is important to consider the impact of any state and local tax regimes that may be applicable to a transaction, although they are not considered in this article.
2 “Limited liability company” or “LLC” is a state law designation rather than a tax law designation. An LLC may elect to be classified as a corporation for federal tax purposes. In the absence of such an election, an LLC with a single owner is classified as a disregarded entity, and an LLC with multiple owners is classified as a partnership, for federal tax purposes. The general principles discussed in this article are potentially applicable to an LLC that is classified as a corporation, a disregarded entity or a partnership for tax purposes, although the tax treatment of a seller in each case may not be exactly the same. The LLC being sold in the examples can be viewed as “any LLC,” or more broadly, any of a corporation, a partnership or a disregarded entity, although one should keep in mind that additional considerations and nuances, left out here for brevity and simplicity, would apply depending on the LLC’s federal tax classification.
3 Although in certain cases the seller’s net overall gain may consist (especially for an LLC classified as a disregarded entity or a partnership for tax purposes) of gains with respect to some assets and losses with respect to others, the details of these calculations and their potential impact on tax liabilities are not considered herein.
4 The application of each of Section 721 and Section 351 is subject to additional conditions, assumed to be met and therefore not discussed here, that would need to be considered when planning a rollover utilizing one or both of these provisions.
5 The acquiring entity that issues rollover equity is likely to be an entity owned by the fund rather than the fund itself. The legal principles of Section 721 apply to any entity treated as a partnership for tax purposes.
6 The minority owners’ sale of their LLC interests is ignored in order to focus on the founder.
7 As a partner of the acquiring partnership, the founder will be subject to tax on the appropriate share of the partnership’s taxable income each year.
8 The “solely” requirement does not necessarily preclude receipt of additional consideration such as cash or debt instruments from the corporation, but rather requires that the only property that may be transferred without recognition of gain or loss property transferred in exchange for stock of the transferee corporation. Certain types of preferred stock are not treated as stock for purposes of nonrecognition under Section 351 but are treated as stock for purposes of Section 351’s control requirement.
SETH LEBOWITZ
Partner, Sadis & Goldberg
slebowitz@sadis.com
Seth Lebowitz is a partner in the firm’s Tax group. Seth advises clients on the tax-efficient planning and execution of a broad range of transactions, with a particular focus on the formation, operation and investing activities of private equity and hedge funds. Seth has experience with:
• Domestic and international tax issues relating to fund structuring
• Joint ventures and partnerships
• Corporate and real estate investing
• Lending Securities trading
• Distressed investing
• Financial products
Litigation
Arbitration
Investigations
EDUCATION
J.D., Hofstra University School of Law, 1990
Member of the Hofstra University Law Review
B.A., Union College, 1987
ADMISSIONS
New York
New Jersey
Douglas Hirsch is a founding member and co-head of Sadis & Goldberg’s litigation department and has over 30 years of trial and appellate experience. Doug has successfully represented clients in complex securities and business litigation, including class action and derivative cases. Doug advises, litigates and arbitrates primarily for clients in the financial services and real estate industries, and therefore, has extensive experience in the areas of hedge fund, venture capital fund and private equity fund litigation, investment and securities fraud, business and partnership disputes, business divorce and dissolution, corporate governance, cross border insolvency litigation, fraudulent transfer and claw back claims, and real estate litigation.
Doug started his career at Lord Day & Lord, Barrett Smith and then worked at Schulte Roth & Zabel before becoming one of the founding members of Sadis & Goldberg in 1996.
Doug received his J.D. in 1990 from Hofstra University School of law, where he was a member of the law review. He received his B.A. degree in 1987 from Union College. He is a member of the New York bar and has been admitted to the First, Second and D.C. Circuits and the United States District Courts for the Southern and Eastern Districts of New York.
z New York Metro Super Lawyer, New York Metro Super Lawyer Magazine 2013 – 2023
z Top Attorneys in Metro New York, Selected by Peer Recognition and Professional Achievement, New York Times 2015
z 2024 Chambers & Partners New York Regional Dispute Resolution Spotlight
BY ROGER KOWALSKI
DIRECTOR, iGLOBAL FORUM: THE INDEPENDENT SPONSOR SUMMIT
With how rapidly the world has changed in just the past three years, and at the risk of dating myself within the next three; I truly believe that there will never be a substitute for shaking someone’s hand in person and beginning a relationship. Would you ever write a substantial check or enter into a significant and complicated business relationship with somebody without actually having met them in person?
The tools that we have at hand and readily accessible to us nowadays are incredible. We’re video conferencing across the globe at the click of a button. We’re almost all working remotely or at least in some form of hybridmodel. All of this has made communication and introductions much simpler. Don’t get me wrong; this is all good stuff. As a conference organizer, it’s not a threat to me. Heck, we even have our own online platform designed
for independent sponsors to meet capital providers (and vice versa) so that they can collaborate without attending and paying for our summits. But these tools are merely the first step. There will always be a need to network in-person, brand yourself as a player in the space, and be seen as a thought leader in order to differentiate yourself from the pack.
With so much riding on just a few days or a few hours, how can you ensure that you make a lasting impression and walk away with tangible results?
As a seasoned conference organizer, I’ve witnessed firsthand what separates successful networkers from the rest. Whether you’re attending a high-stakes conference or a casual industry mixer, following these five key strategies will enhance your effectiveness and help you get the most out of your next networking event.
Effective networking starts before you even set foot in the room. Preparation is the foundation of success. Before attending, truly identify what you hope to achieve. Give yourself KPIs or a number to hit. Challenge yourself. Are you looking to meet potential clients, partners, investors, or mentors? Once you’ve clarified your goals, research who will be attending and create a target list of people you’d like to connect with. Use social media platforms like LinkedIn to learn more about these individuals, their roles, and their organizations. Do your due diligence on who you or your firm already has a relationship with. These folks might be important to stay front of mind with, and it might be easier for you to feel comfortable
around people that you already know, but don’t fall into the trap of spending all of your networking bandwidth amongst people that you already have access to.
Create an elevator pitch that clearly communicates who you are, what you do, and how you add value. Practice this pitch until it feels natural and adaptable to different conversations. I always counsel people to “find [your] own voice.”
Pro Tip: Have a few thoughtful conversation starters ready, such as something that the company of the person that you’re talking to recently did, recent industry trends, or event-specific topics to break the ice.
Where you position yourself during the event can have a significant impact on your networking outcomes. Upon arrival, position yourself near key gathering areas such as refreshment tables, high-traffic areas, or places where people naturally congregate between sessions.
Make it a priority to ask questions of the panel if this opportunity presents itself to you. If the conference offers you a microphone while sitting in the crowd, even better. Stand up proudly, introduce yourself (quickly, please…), and ask an intelligent question in front of your peers. They will notice you.
If you are attending with a colleague or a partner from your company or firm, endeavor to sit at different tables during lunch and other networking sessions. Find seats away
from one another during the talks and panel discussions. Seated together, you might meet 10 people. Seated separately, you will meet 20 people.
Pro Tip: Focus on quality over quantity.
It’s better to have a few meaningful conversations than to collect a stack of business cards from superficial encounters.
Networking is about relationship-building, not merely transactional exchanges. Avoid diving straight into business talk. Instead, aim to create genuine connections by finding common ground, whether it’s shared interests, experiences, or mutual contacts.
I’ve created long-time friendships and even lasting sponsorship relationships that began with small talk over a dumb thing that my son happened to do while playing basketball.
Once engaged in conversation, prioritize active listening over self-promotion. People appreciate being heard, and by asking open-ended questions, you create a deeper connection. The first sales book that I ever read was Carnegie’s “How to Win Friends…” and there was a study mentioned in the first half of the book where hundreds of phone calls in the early part of the 1900s were analyzed
and studied, and the theme/words that came up most often were iterations of “I” and “Me.” People love talking about themselves. Ask questions to get a foot in the door and listen to identify opportunities where you can provide value. This builds trust and rapport.
People are more likely to do business with someone they trust and feel comfortable with. Show genuine interest in others’ work and lives by asking questions and sharing insights. Be authentic and personable in your interactions—people can sense insincerity from miles away.
Pro Tip: Don’t view each conversation as a potential business lead. Approach networking with a mindset of curiosity and collaboration rather than competition.
Avoid being a ship that passes in the night. All of the effort you put into networking at the event will be wasted if you don’t follow up. Effective follow-up transforms fleeting conversations into lasting relationships. Within 24-48 hours after the event, send personalized emails or LinkedIn messages to the people you connected with. Reference something specific you discussed during the event to jog their memory and reaffirm the rapport you established.
When appropriate, suggest a next step, whether it’s scheduling a coffee meeting, a drink, a call to explore synergies, or simply staying in touch for future opportunities. Consistent follow-up is crucial in keeping the momentum going. You want to be remembered the next time that they pick up the phone.
Pro Tip: This is old school, but stay organized by keeping a record of who you met, their contact details, and key discussion points. This makes follow-up easier and more tailored.
Paul Marino at Sadis & Goldberg showed me a NFC-Enabled chip that was stuck with doublestick tape on the back of his phone so that all he needed to do was tap his phone to mine and we were brought to each other’s LinkedIn page where we could connect. Who even needs cards anymore!?
Making a lasting impression requires standing out from the crowd. Your personal branding and the way you present yourself can have a big impact. Dress appropriately for the event but add a personal flair that makes you memorable, whether it’s a unique accessory, a signature color, or even a compelling story you share during conversations. I may not be movie-star handsome, but I wore a powderblue suit at our conference in Miami and had a baritone voice on the microphone.
When introducing yourself, focus on how you can help others rather than on what you need. My experience as a conference organizer will be different from yours, but after somebody says hello to me I just about always ask them what deal they’re working on, what industry
it’s in, and who I can help introduce them to. You’d be shocked at how many jaws I see hit the floor. It’s almost as if nobody expects a conference producer to care about them and willingly show that he wants to help! This sets you apart as a valuable connection and increases the likelihood that people will remember you long after the event.
Pro Tip: Have fun with it, find your own flair, and position yourself as a resource.
“With so much riding on just a few days or a few hours, how can you ensure that you make a lasting impression and walk away with results?”tangible
Networking is an art, and like any art form, it requires practice, intention, and strategy. By preparing with purpose, positioning yourself strategically, building genuine relationships, following up effectively, and being memorable; you can maximize the impact of your
ROGER KOWALSKI Director, iGlobal Forum: The Independent Sponsor Summit
networking efforts. At the end of the day, successful networking is about giving as much as it is about gaining—so approach each event with the mindset of how you can help others, and you’ll be surprised by how much you receive in return.
iGlobal Forum is the organizer of the longest-running Independent Sponsor Summit in the country and has worked to help advance the independent sponsor space since 2013.
We specialize in exclusive senior-level forums focused on today’s most significant business issues. We offer a platform for business connections, education, and advisory services for leading Fortune 1000 companies and industry practitioners. Our events are attended by selected corporate CEOs, senior management, business entrepreneurs, as well as representatives from non-profit and government organizations. We enjoy the participation of large institutional investors, asset managers, hedge funds, private equity, venture capital, investment banks, consultants, and law firms. Please visit www.iglobalforum.com for more information about our company.
Connecting senior-level executives and decision-makers in the financial and CRE industry for over 15 years
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We can help you navigate the complexities and crucial steps it takes to prepare your company for sale and maximize its value for a successful exit.
Ready to maximize your company’s value? Let US Capital Global guide you through the sale preparation journey. Don’t leave success to chance. Partner with us today for a prosperous exit. Contact us now!
Mitchell R. Cohen, Esq., Partner mcohen@uscapital.com +1 609-828-1788
Peter Gabriel, Executive Managing Director pgabriel@websterbank.com 203.328.8110 websterbank.com
This exclusive 1 day event focuses on high level networking opportunities between Capital Providers and Independent Sponsors. Scan the QR code now to register!
Event Format
12 speed networking meetings (20 minute sessions)
Panel discussions and Keynote Speaker
2 hour social networking cocktails
Curated dinners upon request
Additional connecting and an attendee participant book
THURSDAY
JANUARY 30TH, 2025
8 a.m. - 6 p.m.
FAENA FORUM
