Make a personal plan for your exit or IPO

Whether you’re a founder, an early employee or an executive, the possibility of an exit offers extraordinary financial possibilities.

However, I see plenty of founders having liquidity events only to find themselves making hurried decisions with their newfound wealth, ultimately feeling frustrated when they realize they’ve paid a painful price by not having the proper advice. 

Typically, I recommend breaking your planning into two separate phases to reduce overwhelm and maximize your wealth: planning before an exit and planning after an exit.

Determine your goals and strategy

Before an exit, it’s important to coordinate planning and hammer out key details that will carry you through the sale of your business. This typically means teaming up with a financial adviser, an accountant, and an estate planning attorney. Just as you’ve built the team of your company to help your business grow and succeed, it’s important to build a team that’s coordinated and focused on your personal financial success both now and in the future. 

Spending time upfront to determine your goals, objectives, and desired lifestyle can save you endless headaches on the back end of an exit, possibly save you a surprising amount in taxes and set you up for long-term success and fulfillment.

Taxes and QSBS

Speaking with a professional can help you determine what tax savings opportunities would be most applicable to your specific situation. For example, if you’re a startup founder, you may qualify for the QSBS exclusion (qualified small business stock). This exclusion could, if you qualify, allow you to exclude up to $10 million, and sometimes multiples of that, in federal capital gains tax after selling your stake in the company. 

One of our clients whose company was being acquired did not know whether he would qualify for the QSBS exclusion when he was introduced to us. By coordinating with his corporate counsel and accountant, we determined he would. In this specific situation he had acquired the domestic C Corporation shares of his tech company, and held them for over five years by the time the acquisition happened. And when he initially obtained the shares, the gross assets of the company were less than $50 million. Needless to say, he was pleased to learn that the first $10 million of his gains were exempt from federal tax!

Requirements to qualify for QSBS include but are not limited to:

  1. Domestic C corporation stock acquired directly from the company and held for over 5 years
  2. Stock issued after August 10, 1993, and ideally, after September 27, 2010 for a full 100% exclusion
  3. Gross assets of the company must be less than $50 million when the stock was acquired 
  4. Active business with 80% of assets being used to run the business; cannot be an investment entity
  5. Cannot be an excluded business type such as, but not limited to finance, professional services, mining/natural resources hotel/restaurants, farming or any other business where the business reputation is a skill of one or more of the employees.

Estate planning and wealth transfer

Many founders and startup executives are still early in their career, but my team and I are always surprised by how many new clients we speak with who’ve never considered estate planning. Start with the basics: a will, health care directive, power of attorney, a living trust and term insurance. Each of these elements helps to protect your wealth, your stake in your company and creates a clear path to protect you and your loved ones in a worst-case scenario.

An estate planning attorney can partner with your financial team to ensure that all the details are ironed out and that no part of your estate is left out. Currently, the estate and gift tax exemptions are at all-time highs, so you may even discuss gifting a large portion of your wealth to the next generation now to minimize future tax implications and start building your legacy. 

Some of the more commonly used advanced estate planning techniques seek to take advantage of a future expected pop or increase in value of pre-exit / pre-IPOs shares. If you feel the value of your company may “pop” in the future, this is an excellent opportunity. There are numerous strategies that our founder clients use, but one of the most commonly used is the Grantor Retained Annuity Trust (GRAT). GRATs allow founders to transfer shares into a trust for a set time period (usually 2-5 years), for the benefit their current or future family. During that time, the founder receives annuity payments back from the trust, plus an interest rate referred to as the IRS 7520 rate. These annuity payments can be structured so that all assets put into the trust, will be returned to the founder. At the end of the term, any value remaining in the trust is transferred gift and estate tax free to the beneficiary(s).

Charitable planning

If you are philanthropic, charitable planning should be considered to offset some of the taxes connected with the exit and maximize your charitable donation power.

For example, you might set up a Donor Advised Fund or a Private Foundation that is funded with appreciated stock. Both Donor Advised Funds and Private Foundations could allow you to take the tax deduction in the year in which an exit happens, and then decide when and where to donate in subsequent years.  

We have a client whose company was acquired recently by a large public company. He made the decision to fund a Donor Advised Fund during the tax year in which the transaction happened by donating a portion of his appreciated stock. Rather than having to sell the stock, pay capital gains tax, then donate the remaining cash, he was able to take the tax deduction equal to the fair market value of the stock he contributed. For him, this was a powerful way to get a tax deduction in the year of his liquidity event, maximize his charitable donation power, and decide at a later time the charitable organizations he’d like to support. This is just one of the many ways you can make an impact and start building your legacy, all while creating a financial strategy that sets you up for success.

Planning after liquidity: executing your strategy and mitigating risk

Once an exit occurs, your goal should be to protect your wealth by executing your strategy and mitigating long-term risk. Your financial adviser team can help you run point on creating and executing this strategy and guide you through coordinating the rest of your team of professionals.

Cash flow and financial planning

Up until now, 99% of your mental focus has been growing a successful business – not about managing a large influx of cash in your personal life. Budgeting after a liquidity event adds another layer of complication. There’s a temptation to open the floodgates of your bank account. As well-deserved as that may be after years of pouring time and energy into your business, it’s also important to align your spending with your values in a sustainable way. 

We recommend creating four categories that include lifestyle, big purchases, wealth transfer/family assistance, and philanthropy. And then, model out real-life scenarios so that potential outcomes can be evaluated, and changes can be made if necessary

As an example, we were doing some planning with a founder who was nervous about the markets. His primary concern was that his lifestyle might be affected if there was another financial crisis, so we modeled this out for him. What he realized after seeing the simulated outcomes was that the amount of wealth he possessed would last, even through another financial crisis, as long as he stuck to his budget. This was helpful for him and allowed him to move on from worrying about daily market fluctuations, to thinking about longer term legacy planning.

An exit now means that you start asking questions like:

  • What lifestyle can I afford and maintain?
  • Do I ever have to work again?
  • How much house can I afford now?
  • I’ve always wanted to buy a vacation home, is that feasible?
  • I want to take care of my aging parents, and elevate their lifestyle; how do I do that?

Having the cash flow to accomplish some of these bigger life goals is amazing, but it must be managed with longevity in mind. Putting a system in place that prioritizes these goals can help you to answer a lot of these questions.

Investing and risk management

One of your first steps after a liquidity event that we recommend is to diversify your equity so as  to lower risk. Having a notable amount of concentrated stock in your company after an IPO can pose a risk to your portfolio. However, there are specific restrictions that may prevent you from diversifying right away. 

Your stock may be locked up for 180 days after an IPO and you may be subject to blackout periods where you cannot sell your stock. However, if you plan in advance, you may be able to utilize a trading plan that fits within SEC Rule 10b5-1, which allows certain trading without violating corporate policies or securities laws. You might also consider a variety of other hedging strategies, such as equity collars, prepaid variable forwards, or exchange funds.

The point here is that to the extent possible, you should minimize the risk of being overly concentrated in your investments after a liquidity event.

The bottom line

Your ultimate goal as a founder preparing for an exit is to preserve your assets, minimize tax to the extent possible, and set yourself up for the future. For those fortunate enough to be in this situation, planning in advance and having the right financial team in place can help make your goals a reality.