It's a conundrum. You want to get some liquidity for your ownership in your company, and often you have partners and/or employees with equity stakes as well. But to make this equity worth anything, it seems you have to sell to some other company or a private equity group (you can fantasize about an IPO too, but the chances are similar to most high school basketball players making a living in the NBA).
But selling out may seem like, well selling out. Oh sure, the buyer will promise to keep your employees and maintain the values you have worked so hard to establish in the company. Sometimes they actually do, but too often sellers end up somewhere between disappointed and betrayed--and their employees looking for other work.
Fortunately, there are ways to "sell in" instead of selling out.
The simplest approach is for the company to buy back the stock. This must be done with after-tax dollars. Equity holders who paid for their shares get capital gains treatment on the sale if they are effectively exiting the business; otherwise, dividend rates apply. Currently, there is little difference between the two, however, unless the owner has a substantial basis in the shares, in which case capital gains treatment is preferable. The shares can be retired (meaning the enterprise value of the company goes down, but the per share value of remaining shares remains the same) or made available for sale to other buyers or for awards to employees.
2. Sales to Employees
Employees can buy shares from sellers. The purchase is with after-tax dollars; the proceeds are taxed as a capital gain. Some companies pay employees a bonus to use to buy the shares or loan the money at a reasonable rate, which right now could be very low without incurring a tax problem. It is also possible to set up an internal stock market. The details are beyond the scope of this article. Suffice it to say here that the SEC has made it possible to do this is a way that avoids most significant regulatory burdens.
3. Outside Investors
We have seen a growing trend in recent years for investors in private companies, whether angel investors or private equity firms, to be willing to invest in closely held companied with the intention of selling to another investor group in 5-7 years instead of forcing a sale to another company. This lets the company stay private, but be aware that these investors may want some level of control even for a minority interest, preferred stock, and/or a relatively high rate of return on their money.
4. Secondary Markets
If your company is a high-flyer with real prospects to go public at some point, there are now secondary markets such as NASDAQ's SecondMarket and SharesPost, that allow investors to buy equity (usually equity held by employees in the form of options or restricted shares). These rights are then traded on the market until a liquidity event. Only the most promising companies can do this, however.
Employee Stock Ownership Plans (ESOPs) are highly tax-favored ways for companies to redeem their own shares by setting up an employee benefit trust similar to profit sharing or 401(k) trusts that are designed to hold company stock. Companies can use pretax money to redeem the shares through the ESOP, which then allocates them to employees. All full-time employees with a year or more of service are included and allocations are based on relative pay or a more level formula. Sellers can defer capital gains tax on the sale, and S corporation ESOPs can reduce their tax obligation by the percentage of shares the ESOP owns.