Cynthia Yeung owns 10% of the common shares of Bantam Brokers Ltd. She had acquired the shares, which have a stated paid-up capital amount of $1,000, from a previous shareholder in 20X0 at a cost of $20,000. Since 20X0, Yeung has worked for the company as a senior broker earning a salary and commissions. The remaining 90% of Bantam’s shares are owned by three other senior executives of the company.
Yeung has decided to leave the company and has agreed to dispose of her Bantam shares, which have a current fair market value of $60,000. A shareholders’ agreement stipulates that she must sell her shares either to the other shareholders or back to the corporation for cancellation, with payment terms to be negotiated.
Currently, Bantam does not have substantial cash resources, nor does it have non-business properties that it could sell and convert into cash. Consequently, if the company is going to buy back its shares from Yeung for $60,000, deferred payment terms will have to be established. Similarly, none of the other shareholders have any cash reserves. Although each earns a high salary, all have committed their income to personal expenditures. In addition, none of them holds any other investments, and each looks to the company as his/her sole source of cash.
After a negotiation, these options are presented to Yeung:
1. Bantam will buy back her shares immediately for $60,000. Payment would involve $20,000 cash, with the balance of $40,000 paid in two annual instalments of $20,000, with interest at 8%.
2. The other shareholders will immediately purchase her shares for $60,000 under terms identical to those in option 1.
The other shareholders realize that if Yeung accepts option 2, they will have to either borrow the money from a bank to make the payments or distribute funds to themselves from the company. Even if they borrow the money, they will have to look to the company for help in repaying the principal. Bantam is a Canadian-controlled private corporation and has annual profits of approximately $100,000. Its dividends are normally classified as non-eligible. Yeung, like the other shareholders, usually pays personal tax at the rate of 45%.
Required:
1. Which option should Yeung accept? In your answer, include a comparative analysis of the options listed, and state any assumptions you feel are necessary. Yeung has already used her full capital gains deduction.
2. If you were one of the other shareholders, which option would you prefer? Explain.