ULTRA HIGH NET WORTH BUSINESS WEALTH STRATEGIES
Maximizing the benefit of selling a private business is a lot like improving portfolio performance. It’s a matter of determining exactly what you want to accomplish. That what (whatever it is) is different for every business owner and every investor.
Meet Mary, Steve, and Bob. All three are private business owners at pretty much the same stage in their lives. All three of these accomplished businesspeople is looking to transition out of their daily work routine so that they can enjoy the fruits of their labor.
Mary The Tech Entrepreneur Takes Stock
Mary often quips that one day she was running a successful business and the next day she was at her kitchen table staring at the single stock certificate she took in exchange for it. Mary recently sold the business that had defined the most recent fifteen years of her life. It was a software company she built from the ground up.
It was acquired by a much larger competitor – a public company eager to get into the niche market that Mary had so successfully snatched away from it. The acquirer paid for Mary’s company using shares of its common stock valued at slightly more than $20 million.
Cashing out brought her an enormous windfall. But it also created something of a liquidity problem for Mary. The acquisition was made with shares of stock that were restricted under SEC Rule 145. Mary couldn’t sell the stock for two years, unless the acquiring company registered it before then. She was faced with a couple of concerns.
She wanted to reduce her concentration risk, which literally put her into a situation where all of her eggs were in one basket. And she wanted to create a diversified portfolio that would give her an opportunity for both future growth and current income.
But she had two problems, or so she thought. Mary couldn’t sell the stock. That’s for sure. So she believed that she wouldn’t be able to create the diversified portfolio that would give her the financial serenity she desired.
Mary’s concerns are the type that Pillar Wealth Management was created to address. We wrote the book on protecting ultra-high net worth. The financial planning we perform takes every aspect of our clients’ lives into consideration and Mary’s predicament is one we’ve seen before.
Mary actually has a number of options. There are risk mitigation strategies designed specifically for holders of concentrated stock positions. We are familiar with every one of them.
We know which strategy makes sense for a specific individual based on a holistic understanding of that person’s unique circumstances. That comes from knowing exactly what they want to accomplish – whatever that what is!
In the case of a holder of a concentrated stock position, risk mitigation strategies can be matched to an individual’s unique objective. Structures can be created to provide downside price protection, portfolio diversification, or income generation.
The devices used to accomplish these may include listed or over the counter options, costless collars, prepaid variable forwards, exchange funds, derivative swaps, or stock protection trusts.
In Mary’s case a prepaid variable forward made sense. It provided her an opportunity to sell some of the stock (as of a future date). The proceeds from that forward sale were used to create a hedge against downside risk and help her create a durable diversified portfolio that gives her the inner peace that comes from knowing that she’ll be taken care of even if the concentrated stock position declines in value.
Steve’s Kids Run the Toy Factory
Steve started making children’s toys back in the 1970s after he graduated from college. Since its beginning, his factory has made pretty simple mechanical playthings that operate on batteries, but for the most part, are relatively simple gadgets.
Nevertheless, the toys have an endearing quality that has brought them a large following and helped make Steve a multi-millionaire.
Steve planned on retiring after his 75th birthday. His two daughters wanted to keep the factory going and introduce changes to make the product line more interactive, without the toys losing their charm.
So the three of them agreed that Steve would sell the company to them. An independent valuation firm estimated that the business was worth $5 million and that was the price they agreed upon. But this presented the trio with two problems.
How could the transfer of ownership be made without incurring a huge capital gain? And how could Steve cash out without saddling the business (and his girls) with enormous debt?
These are exactly the types of questions Pillar Wealth Management helps ultra-high net worth families answer. As a practical matter, there are really only a couple of ways to transfer ownership of a business to family members.
It can be sold or gifted. There is subtle nuance between these two extremes, but giving the business away or selling it frame the boundaries of what the owner can do.
Because we act as our clients’ financial stewards and have helped some of them with trustee selection and family governance, we have seen every conceivable mechanism for transferring generational wealth. And this is the essence of Steve’s dilemma. Luckily, there was a near perfect solution.
Since Steve’s 75th birthday was still five years away, he and his daughters decided that the business would be conveyed using a Grantor Retained Annuity Trust (GRAT). The trust was established to terminate in five years, at which time the business would be transferred to Steve’s daughters.
The trust paid him $1 million a year from the company’s free cash flow, which was enhanced by the revenue growth generated from the new product line. By the fifth year, the business was actually worth $8 million, had a solid balance sheet, and was more profitable than ever! Steve and his daughters accomplished every one of their goals and more.
Steve used the $5 million he received from the trust to build a retirement nest egg. His daughters got to keep 100% of the increased value they built in the company. And the transfer of the business remained a private matter, because it transferred by trust. So, there were no public records.
Bob’s Clear Path to Retirement
Bob has always been a planner and from the start of his career in advertising had a clear vision of his goals. He grew his sole proprietorship into the largest full-service advertising agency in the local market and won national attention and numerous awards in the process.
So it was no wonder that his agency was pursued by similar firms looking to expand their geographic footprint. Ultimately, Bob found the right suitors and entered into merger discussions with them.
The structure of the new company would be a limited liability partnership with the owners of the previous entities becoming partners of the new company. Bob, being the planner he is and with many years of employment still ahead of him, wanted to make sure that the deal provided him with a dependable path to the carefree retirement he envisioned.
He wanted to make sure that if the firms merged there would be a well thought out succession plan for the executives and that adequate mechanisms were in place if things didn’t go as planned or if something happened to one of his new partners. Bob knew that selling a service business can be difficult because its assets are the people who deliver that service.
As trusted financial advisors to entrepreneurs like Bob, Pillar Wealth Management is often asked to comment on areas of their lives and businesses that have nothing to do with managing investments.
We are fiduciaries and proactive wealth managers who pay attention to everything that could impact our clients’ peace of mind. We counsel business owners in Bob’s situation all the time. We work closely with our clients, their legal counsels, tax advisors, and financial intermediaries on a host of business issues from succession planning to funding arrangements. As such, Bob’s concerns are ones we’ve helped many business owners alleviate.
The operating agreement that Bob and his new partners entered into included a well-defined buy-sell provision that spelled out how ownership would be divided up if one of the partners left the business.
They put into place key person insurance to help finance that transition in the event one of them passed away. They merged the separate companies’ 401(k) plans and created new defined benefit and deferred compensation plans. Their operating agreement formalized the partnership’s capital structure and defined how employees would ultimately buy into it as they transitioned to becoming owners.
The merger and careful planning of the partners created something of perpetuity. The new ad agency’s formal plan to promote employees to replace retiring partners gave Bob the clear path to retirement and peace of mind he desired.
Let’s Start a Conversation
Whether you are currently contemplating the sale of your business, a transaction is imminent, or the thought of a change isn’t even on your radar, we should talk.
We are advisors to ultra-high net worth individuals and families and can provide exceptional added value across a multitude of financial, estate, and retirement planning matters for those with liquid assets between $5 and $500 million.
Chances are that we have counseled someone just like you, in your current position, about something important to you. That’s why we invite you to contact us to explore the many ways we can be of service. Our number is (800) 669-6780. Reach us on the web at https://pillarwm.com/ or email us at [email protected]