Some will argue that you can buy back at a price above the 409A, and they make different arguments, including that there’s not really a market at that higher price. Our view is that’s a hard argument to win with the IRS where the company or an insider is paying a premium.
The nuance is that there’s language in the tax regulations that says if a stockholder gives compensation to an employee, then that’s treated as if it were payment by the company. So then the question is: In what circumstances is the stockholder paying compensation to employees? That’s where it’s a gray area.
Here are two real examples. We had one buyback arranged by a party that already owned 50 percent of a company. The consensus view is that’s the same as the company, so any premium is compensatory.
We had another case where it was an 18 percent stockholder. Our view is that’s not compensatory, because it doesn’t make sense for that stockholder to carry the entire burden of compensation on their backs to the benefit of all stockholders.
Oftentimes, there are other factors you can point to. In this instance, the stockholder has investing guidelines that says that it has to have at least X percent. It bought in the preferred round but it really wanted a lot more stock, and it would have bought it from the company, but the company wouldn’t sell because the other stockholders didn’t want that level of dilution.
In that case, the auditor took the position that it was compensatory. We mustered a variety of arguments and convinced them that, in that instance, it was not compensatory. Each individual situation is looked at on its own.