When this service fits
If a closely-held corporation has shareholders exiting (voluntarily or under pressure) and remaining or incoming shareholders, this is the service. The work covers the buyout transaction, the post-transaction governance, and the tax sequencing that makes the deal efficient for everyone.
Buyout Structure Calculator
Six inputs about the deal produce a recommended structure (redemption, cross-purchase, or hybrid) plus the specific documents and tax filings that go with it. Directional; the engagement memo refines it with the actual record.
Educational tool. Not legal or tax advice. Real structure depends on facts the calculator cannot weigh, which is what the intake conversation is for.
Redemption vs cross-purchase vs hybrid
The first structural choice is who buys the exiting shareholder's stock. The choice changes the balance sheet, the basis of the remaining shareholders, the cash flow, and the tax treatment for everyone at the table.
| Factor | Redemption | Cross-purchase | Hybrid |
|---|---|---|---|
| Who buys the shares | The corporation | The remaining shareholders, personally | Both, in defined portions |
| Source of funds | Corporate cash, corporate borrowing, or corporate note | Shareholders' personal cash, personal borrowing, or personal note | Combination |
| Basis impact on remaining shareholders | No increase in remaining shareholders' stock basis | Remaining shareholders' basis increases by purchase price | Partial basis increase |
| Exit shareholder treatment | Sale or dividend per §302 tests | Capital gain or loss on personal sale | Mixed |
| Best for | Corporation has cash; want simple structure | Remaining shareholders want stepped-up basis | Large deals where neither source alone covers the price |
The basis trade-off. A pure redemption is administratively simpler but the remaining shareholders inherit no basis increase. A pure cross-purchase gives stepped-up basis but requires the remaining shareholders to personally fund (and personally bear the cash flow). For deals over $1 million, the basis difference can be tens of thousands of dollars in future tax savings, which often justifies the more complex structure.
Tax framework: IRC §302 and friends
A redemption is treated either as a sale of stock (capital gain or loss treatment for the exiting shareholder) or as a dividend to the extent of corporate earnings and profits. The exiting shareholder almost always prefers sale treatment. IRC §302 is the gate.
The three §302(b) tests
A redemption qualifies for sale treatment if it meets any one of three tests:
- §302(b)(1) Not essentially equivalent to a dividend. A subjective facts-and-circumstances test. Useful as a fallback but harder to plan around.
- §302(b)(2) Substantially disproportionate redemption. The exiting shareholder must own less than 50% of the voting stock immediately after, and the post-redemption percentage must be less than 80% of the pre-redemption percentage. Most useful for partial buyouts of a single shareholder, not full exits.
- §302(b)(3) Complete termination of interest. The cleanest path: the exiting shareholder must completely terminate the ownership interest. Combined with the §302(c)(2) family attribution waiver, this is the most common test used in family buyouts.
Family attribution (§318) and the §302(c)(2) waiver
§318 attributes stock owned by spouses, children, grandchildren, and parents to one another. Without a waiver, a parent who sells all her stock to her child's holding company has not "completely terminated" her interest because the child's stock is attributed back to her. The §302(c)(2) waiver lets the exiting shareholder break attribution if she has no continuing interest as officer, director, or employee (other than as creditor on an installment note) and files the waiver with her tax return for the year of redemption.
Common §302(c)(2) trap. The waiver requires that the exiting shareholder not acquire any interest other than as a creditor for ten years after the redemption. Common violations: remaining on as a paid consultant, retaining a board seat, accepting a part-time employment role. If any of these are planned, the redemption likely flunks §302(b)(3) and falls to the §302(b)(1) "not essentially equivalent" test, which is harder to plan around. Better to plan the buyout cleanly and accept a consulting arrangement only if it complies with §302(c)(2) limits.
Special considerations for S-corporations
For S-corps, the redemption affects the Accumulated Adjustments Account (AAA) and may trigger a deemed distribution to the remaining shareholders if structured incorrectly. S-corp redemptions are often hybrid (partial corporate + partial personal) to manage the AAA / E&P balance and preserve S-eligibility (the corporation must not have more than 100 shareholders and must keep ineligible shareholders out).
Valuation methods
Five common methods for valuing the exiting shareholder's stake. Most deals use a combination.
- Book value. Stockholders' equity from the most recent balance sheet, divided by shares. Easy and predictable, but often understates value for established businesses with goodwill or going-concern value.
- Multiple of EBITDA. Trailing 12-month EBITDA multiplied by a negotiated multiple (typically 3x-6x for closely-held businesses, higher for SaaS or recurring-revenue models). Requires clean financials.
- Formula method. Pre-negotiated formula in the bylaws or shareholder agreement: e.g., 1.5x trailing revenue, or 4x trailing net income, or book value plus 1x trailing earnings. Reduces post-event negotiation friction.
- Independent appraisal. A qualified business appraiser produces a written valuation report. Most defensible for IRS purposes, especially for §302 and §1014 questions. Required for some types of ESOP transactions.
- Negotiated price. The parties agree on a number. Works when both sides are well-informed; risky when one party lacks information or there is a relationship tilt (family business with one informed and one uninformed party).
What the IRS looks for. A defensible valuation has contemporaneous documentation: a written report, a clear methodology, and reasonable inputs. The IRS scrutinizes family redemptions and related-party transactions; a credible third-party valuation is strong protection against an under- or over-valuation challenge. For deals above $5-10 million, an independent appraisal is essentially required.
Payment terms and notes
Most buyouts include some installment component, both because closely-held companies rarely have all the cash at closing and because installments give the exiting shareholder a reliable income stream.
Lump sum at closing
Cleanest structure: all cash on the closing date. Best when the corporation has accessible cash or can borrow. The exiting shareholder recognizes gain or loss in full in the year of closing.
Installment note
Periodic payments over 1-10 years. Common terms: monthly or quarterly installments, fixed amortization, IRS-imputed interest at the applicable federal rate (AFR) or a higher negotiated rate. The exiting shareholder may elect installment-method reporting under §453, deferring gain recognition over the payment period (subject to interest charge for installment obligations over $5 million).
Earnout
Portion of price contingent on post-closing performance (revenue, EBITDA, customer retention). Useful when valuation is uncertain or remaining shareholders want skin-in-the-game from the exiting shareholder during transition. Creates ongoing relationship complexity and adds drafting work for measurement, audit rights, and dispute resolution.
Security for installment payments
Ways to secure the exiting shareholder's installment note: pledge of remaining shareholders' stock (cross-default with operating covenants), personal guarantees from remaining shareholders, escrow of a portion of the price, UCC-1 lien on corporate assets, life insurance on remaining shareholders. The right package depends on deal size and counterparty risk.
What I do, step by step
- 30-minute fact-pattern review. I read the current bylaws, any existing shareholder agreement, the most recent cap table, and the latest financials. Identify any existing buy-sell provisions, valuation formulas, transfer restrictions, or veto rights that govern the transaction.
- Engagement memo with budget. A short written memo summarizing the recommended structure (redemption / cross-purchase / hybrid), the §302 plan, the valuation approach, the document set, and a Phase 2 budget estimate. The memo is a complete deliverable; you can stop after Phase 1 if you choose.
- Draft the buyout package. Stock redemption or stock purchase agreement, promissory note, board resolutions, shareholder consents, mutual releases, §302(c)(2) family attribution waiver if applicable, updated stock ledger, certificate cancellations, and the new or amended bylaws and shareholder agreement.
- Coordinate with the CPA. The buyout has multiple tax touchpoints (§302 treatment, §453 installment election, AAA / E&P tracking for S-corps, basis adjustments, transfer taxes if any). I coordinate with your CPA on the tax filings, but the CPA executes them.
- Closing. Signature collection, escrow funding if applicable, certificate cancellation, updated cap table, post-closing state filings (amended articles, statement of information, foreign-qualification updates if board composition changed).
Documents in a typical buyout package
Stock redemption or stock purchase agreement
The core deal document: parties, purchase price, payment terms, representations, indemnities, closing conditions, releases.
Promissory note (if installment)
Principal, interest rate (at or above AFR), amortization schedule, default provisions, cross-default with operating covenants.
Security agreement / UCC-1
Where installment payments are secured by corporate assets, the security agreement creates the lien and the UCC-1 perfects it.
Personal guaranty (where applicable)
Remaining shareholders guarantee the corporation's payment obligations on the installment note. Critical leverage piece for the exiting shareholder.
Board resolutions
Board approval of the redemption (corporate-side authority for the corporation to buy back its stock).
Shareholder consents
Where bylaws or state law require shareholder approval of the redemption, the unanimous or majority shareholder consent in writing.
Mutual release
The exiting and remaining shareholders release each other from claims arising from the prior business relationship, with appropriate carve-outs for the transaction documents themselves.
§302(c)(2) family attribution waiver
Where family attribution rules would otherwise prevent the exiting shareholder from getting sale treatment. Filed with the IRS via the exiting shareholder's tax return for the year of redemption.
Updated stock ledger and certificate cancellation
Old certificates retired; new certificates (or book-entry records) issued. The stock ledger reflects the post-transaction cap table.
Updated bylaws
New board composition, voting thresholds, transfer restrictions, drag/tag provisions. See Corporate Bylaws Drafting for the standalone playbook.
Amended shareholder agreement
If a shareholder agreement was in place, it needs updating for the new cap table, new buy-sell triggers, and any new voting blocs.
State filings
Amended articles or statement of information if officers, directors, or registered agent changed. Foreign-qualification updates in states where the corporation does business.
Common pitfalls
- ✗Ignoring existing buy-sell terms. If the bylaws or shareholder agreement already has a buy-sell triggered by exit, the new buyout must comply or expressly amend the existing terms. Drafting a fresh stock purchase agreement that conflicts with an existing buy-sell creates a contract dispute risk.
- ✗Skipping the §302 analysis. Treating a buyout as automatic sale treatment without confirming a §302 test is met. If the IRS recharacterizes the redemption as a dividend, the exiting shareholder pays ordinary income tax on the full distribution instead of capital gain on the gain over basis.
- ✗Installment note below AFR. A 0% or low-interest installment note triggers imputed interest under §1274 and §7872. The corporation gets phantom interest income and the exiting shareholder gets phantom interest expense, creating mismatched tax positions.
- ✗Letting the exiting shareholder stay on as a paid consultant after a §302(c)(2) redemption. Violates the waiver and recharacterizes the entire redemption as a dividend.
- ✗Forgetting to update bylaws. Post-buyout governance falls back to either stale bylaws (drafted when there were four shareholders) or default state law. Neither is what the parties intended.
- ✗Skipping the mutual release. Without a release, the exiting shareholder can sue for pre-closing claims (compensation, capital contribution disputes, oppression) months or years after the deal closes.
- ✗No security for the installment note. If the corporation defaults, an unsecured installment-note holder is a general creditor, behind every secured creditor and trade payable.
Fees
Hourly, with a transparent estimate range provided after a 30-minute fact-pattern review. The estimate is a budget cap unless the scope changes.
No contingency. Buyout work is transactional, not litigation; there is no recovery against an opposing party. Hourly billing with an estimate cap keeps incentives aligned on getting the deal done at the right number, not maximizing time.
Start with a 30-minute fact-pattern review
Send me the current bylaws, the existing shareholder agreement (if any), the latest cap table, and a one-paragraph summary of the deal. I will return a written engagement memo within five business days with the recommended structure and a budget estimate.
Start package intake Bylaws-only service