Short answer
An IT managed services owner, 57, sold his business to a private equity backed platform for $11 million: 70 percent cash, 25 percent rollover, a 7.5 percent holdback. Because the business had been a C corporation for more than five years and managed services is not an excluded field, most of his gain qualified for the QSBS exclusion, which erased the federal tax on roughly $8 million of it. Before signing, the buyer's draft allocation was renegotiated to move a large non-compete number back into goodwill. After closing, the plan turned to the harder problem: investing the cash, planning Roth conversions in the low-income years ahead, and treating the rollover as a separate bet worth zero until proven otherwise. He stayed in California, which does not conform to QSBS, so he still owed California tax on the gain.
Key facts
- Headline price
- $11 million (roughly 9 times adjusted EBITDA for a recurring-revenue MSP).
- Terms
- 70% cash, 25% rollover, 7.5% holdback for 18 months, 3-year employment agreement, non-compete.
- QSBS
- C corporation for more than five years, managed services not an excluded field; about $8 million of gain excluded from federal tax. California did not conform, so state tax still applied.
- Allocation change
- Non-compete reduced from $800,000 to $200,000; reallocated to goodwill, most of which was QSBS-excluded anyway.
- After the sale
- Cash invested to a plan, Roth conversions mapped for the low-income years, rollover treated as worth zero for planning.
The situation
Mr. K. was 57 and had spent twenty years building an IT managed services business: recurring monthly contracts, a stable team, and the cybersecurity work that buyers pay up for. Years earlier, on his accountant's advice, he had incorporated as a C corporation rather than an S corporation, a decision that seemed to cost him a little in tax each year and turned out to matter enormously at the end. A private equity backed platform offered to buy the business for about 9 times adjusted EBITDA, which came to $11 million: 70 percent cash, 25 percent rollover into the platform's holding company, and a 7.5 percent holdback in escrow for 18 months, with a three-year employment agreement and a non-compete.
He came to us with the letter of intent in hand but unsigned, and with two very different problems ahead of him. The first was the deal. The second, larger one was what to do with the money once it arrived, which is the part almost nobody had talked to him about.
The deal: QSBS changed everything, and the allocation still mattered
The first thing his CPA checked was QSBS. The business had been a C corporation for more than five years, and IT managed services is not one of the fields Section 1202 excludes, so his stock was qualified small business stock. With a low basis, roughly $8 million of his gain fell within the exclusion and could come out entirely free of federal tax. That single fact was worth more than every other planning move combined, and it existed only because of an entity choice made years earlier. He confirmed it with a written opinion before relying on it, because QSBS is fact-specific and the stakes were large.
QSBS covers capital gain on the stock. It does nothing for ordinary income. The buyer's draft put $800,000 into a covenant not to compete, which is ordinary income taxed at up to 37 percent and gets no exclusion. His attorney was comfortable that a $200,000 covenant still held up, so $600,000 moved back into goodwill, where it sat inside the QSBS-excluded gain instead of being taxed at ordinary rates. The buyer did not care, because it deducts a covenant and goodwill over the same 15 years. That one change saved roughly $200,000 in tax on a point the buyer was indifferent about.
Two more deal points were settled before signing. The rollover was confirmed to defer under the right code section, and he asked whether the platform's holding company might itself be QSBS-eligible for the rolled stock, which his counsel pursued in writing rather than assuming. And he chose not to increase the rollover above 25 percent, because it is illiquid, sits behind the lenders and the sponsor's preferred return, and already represented a large share of his net worth.
The California problem he could not plan away
California does not conform to QSBS. So while roughly $8 million of gain escaped federal tax, California still taxed the gain at its own rates, up to 13.3 percent. He asked the obvious question, whether to move first, and the answer was no. His family, his home, and his three-year role with the platform were all in California, and moving in the year of a sale is the pattern the state audits most closely. The state tax was real and unavoidable, and the plan simply accounted for it rather than pretending it away.
After the sale: the part that actually decides how the money lasts
The deal closed, the cash arrived, and the harder work began. For the first few weeks the proceeds sat in Treasury bills while the plan was built, and nothing permanent was done. Then, in order:
The cash was invested to a plan, not to a habit
As an owner he was used to earning far more than 20 percent on his own company. A diversified portfolio is not built to do that, and expecting it to is how newly liquid owners take too much risk. We sized the portfolio to the income he actually needed and built the reliable version of that, not the aggressive one.
Roth conversions were mapped for the quiet years
His income dropped sharply once the business stopped paying him. The years after the sale, before Social Security and required withdrawals, were his lowest-tax years, so we planned Roth conversions into them. The sale year itself, his highest-income year, was left alone.
The benefits were rebuilt
He lost the company retirement plan, the self-employed health insurance deduction, and the qualified business income deduction. We arranged health coverage to carry him to Medicare and rebuilt the retirement savings plan around his new W-2 role with the platform.
The rollover was set aside
The $2.75 million of rollover equity was treated as worth zero for planning. If the platform sells well in five to eight years, it is a bonus. If it does not, his retirement does not depend on it. He also began gifting a small slice of the rollover units to a trust for his children while their value was low, to move future growth out of his estate.
The number
| Line | Amount |
|---|---|
| Headline price | $11,000,000 |
| Rollover equity (25%), tax deferred | ($2,750,000) |
| Holdback (7.5%), paid after 18 months if clean | ($825,000) |
| Banker, legal, and quality of earnings fees | ($260,000) |
| Cash wired at closing, before tax | $7,165,000 |
| Taxable gain outside the rollover, mostly capital | about $8,000,000 |
| Federal tax on the capital gain (excluded under QSBS) | about $0 |
| Federal tax on the $200,000 covenant (ordinary, 37%) | ($74,000) |
| California tax on the gain (does not conform to QSBS) | about ($1,064,000) |
| Estimated cash after tax at closing | about $6,027,000 |
| Holdback later, after tax, if paid in full | about $700,000 more |
| Rollover equity, at deal value | $2,750,000 |
Two things stand out. The QSBS exclusion turned what would have been roughly $1.9 million of federal tax into almost nothing, which is why the entity decision made years earlier mattered more than anything done at the closing table. And even with that, California took more than a million dollars, because the state does not follow QSBS. The headline was $11 million; the cash in hand at closing was about $6 million, with more coming later and $2.75 million riding on a rollover his plan does not depend on.
What this case study does not show
It does not show QSBS for a business that does not qualify. Most owners are S corporations or LLCs and hold no QSBS at all, and owners in accounting, consulting, and similar fields are excluded no matter their entity. It does not show a second sale, which has not happened and may take years. And it does not show a result you should expect. It shows a sequence: an entity choice made early that turned out to be worth millions, an allocation fight that cost the buyer nothing, a rollover kept small on purpose, a state tax that could not be planned away, and a post-sale plan built on the cash rather than the headline. If your letter of intent is unsigned, most of the deal sequence is available to you. If you have already sold, the after-sale sequence still is. The contact page explains how a first conversation works.
Questions people ask
Is this a real client?
It is a composite. The situation, the sequence of decisions, and the mechanics are drawn from our work with owners selling to platforms. The name, industry details, and dollar figures have been changed so that no client can be identified, and the figures are illustrative rather than a record of any one engagement. It is not a promise of a similar result.
How did QSBS erase most of the federal tax?
His business was a C corporation for more than five years, and IT managed services is not one of the fields Section 1202 excludes, so his stock was qualified small business stock. At the full five-year mark the exclusion covers the greater of $15 million or ten times basis, so his roughly $8 million of qualifying gain was excluded from federal tax entirely. He confirmed eligibility with a written CPA opinion first; QSBS is fact-specific and not something to assume. See the QSBS page.
Why did he still owe California tax?
Because California does not conform to QSBS. The exclusion is a federal break, so a California resident owes state tax on the gain even when the federal tax is zero. He considered whether a move made sense and decided it did not, because his family and his post-sale role were in California and moving in the year of a sale is the highest-audit-risk pattern the state has.
Why bother renegotiating the non-compete if QSBS covered the gain?
Because the non-compete is ordinary income, and QSBS only covers capital gain on the stock. A dollar allocated to a covenant is taxed at ordinary rates and gets no QSBS exclusion, so moving $600,000 from the non-compete back into goodwill kept it inside the excluded gain instead of taxing it at 37 percent. The buyer was indifferent, since it deducts either one over the same 15 years.
Why not roll more than 25 percent?
Because the rollover is illiquid and sits behind the platform's lenders and preferred return, and he already had a large share of his net worth in it. Rolling more would have deferred a little tax in exchange for putting more money at the back of the waterfall for years. His plan was built to work with the rollover worth zero.
What did the after-sale plan actually change?
Three things. The cash was invested to a plan sized to the income he needed, not to the returns he was used to earning on his own company. Roth conversions were mapped for the low-income years after the sale, not the sale year itself. And the retirement accounts, health insurance before Medicare, and the lost business deductions were all rebuilt around his new situation. The rollover was set aside as a separate, speculative piece.