Executives Can Still Buy Shares With a Company Loan

As many of you know, Sarbanes Oxley prevents public companies from loaning money to officers and directors. In the past, this was commonly done for stock purchases. Since Sarbanes Oxley applies only to public companies, it is still possible to buy private company stock via a company loan. The loan however needs to be repaid prior to IPO. As the IPO market opens, we may see more executives buying their stock or exercising options via loans. The principal advantage is starting the one-year holding period for long term capital gains purposes.

The company loan is not without risk. It is a real obligation (that accrues interest) and it must be repaid on maturity. In the dot.com bust we saw many companies (particularly those assigned to a bankruptcy trustee) collect on such loans. The goal is to minimize personal liability by maximizing the portion of the loan that is non-recourse. A typical structure is to have the note be non-recourse and secured only by the underlying shares. However, if the fair market value of the shares at the time of the loan is not significantly greater than the loan amount, then the full loan amount will be deemed ordinary income to the executive. The fix is to have a portion of the loan be full-recourse (meaning the executive is personally responsible for repayment), but the remainder to be non-recourse. To be safe, it is best to follow broker margin rules, which provide for 50 percent loan to value, and thus 50 percent full recourse. There is no IRS direct guidance on this but I think the broker rules are a good place to start.

The executive can view the full recourse portion of the note as a down payment, except they don't need to pay cash, rather they are personally responsible for repayment if liquidity of the underlying shares doesn't materialize. Using the above guidelines, the loan amount should be no greater than 2X the full recourse portion. Of course, it is possible to secure the loan with other collateral, but most people don't want to pledge their car as security.

Remember that these loans do not have a cash impact on the company, they are cash neutral - the money is loaned to the executive and it goes right back to the company.

These loans are not for everyone and most companies and board of directors are disinclined to entertain them. However, for top executives, they may be a useful technique to retain and attract top talent.

There are many more details and considerations than I've outlined here. You should consult your tax and legal advisors before proceeding.