Developing new business is an unavoidable part of being involved in the financial services industry. Everyone needs new customers to be successful.
That’s why advisors have long targeted successful entrepreneurs who have tied most of their wealth to the value of their business. Of course, even if you’re short on cash now, the idea is that things will change the moment you sell the company.
In fact, some advisors are so eager to work with such clients that they offer to oversee their sales process for free in exchange for the opportunity to manage their post-deal assets. However, due to unique circumstances, this can have disastrous consequences for business owner clients who frequently require more than just wealth management related services.
In fact, deals involving tens of millions of dollars often require multidisciplinary advisor expertise. In other words, someone who can work with other service providers such as chartered accountants, M&A professionals, and real estate attorneys to implement pre-transaction planning strategies to help clients protect as much of their assets as possible.
Here are some strategies to help paper-rich, cash-poor entrepreneurs get the most out of their business sale.
Use valuation discounts when gifting assets. Assuming the business is an LLC, it is possible to offer heirs large gifts and set up arbitrage opportunities for clients once the transaction is complete. Here’s how it works: Let’s say the business is worth him $100 million. Owners can give 10% of it to their children through a trust. Because it is a minority stock, it may become a minority shareholder and may not receive a marketable discount, reducing the amount awarded. In this case, it’s likely about $8 million, meaning there’s potential for more gifting in the future (the current lifetime exemption amount is $12.92 million per person). Additionally, the beneficiary’s interest in the trust is still $10 million and could be worth even more if the business changes hands again.
charitable donation. There is nothing new in establishing charitable trusts and donor-advised funds to support the causes that our clients are passionate about. Still, for corporate sellers, the timing of doing this is critical. Must be done before the transaction is completed. That way, you can fund it immediately, avoid capital gains tax on your donation, and receive a charitable deduction from your donation’s fair market value. Funding one of these vehicles after the transaction has taken place would not have much of an impact from a tax perspective. In particular, advisors should look at their clients’ philanthropic objectives through the lens of broader financial planning. The last thing you want is for them not to have enough money left to work on other goals in life.
Exclusion of Eligible Small Business Stocks. This little-known peculiarity of the IRS tax law allows owners (including founders) of qualifying company stock to avoid paying taxes on the first $10 million in earnings in that stock. There are conditions such as the company can not operate. Various prohibited industries (However, technology, wholesale, retail, and manufacturing are permitted.) You must also be a C-Corp with less than $50 million in assets. Also, the owner must have owned the shares for at least five years. This highlights why pre-deal planning is important for corporate sellers. Imagine they ended up selling their company and their four-and-a-half-year-old stock.
take a deep breath and wait. After years of very little liquidity, business sellers can suddenly find themselves in a flood of cash. This is clearly a good question. The first step is to review your current estate planning documents. Have your previous intentions changed in light of your newfound wealth? Another problem is that you no longer own rapidly growing assets, so your balance sheet may be smaller than before. So it’s a good idea to encourage these types of clients to adhere to a post-sale cooling-off period. Do their friends want to invest in real estate funds? Do they want to buy a big house or an expensive sports car? All of this can wait until its goals and objectives can be determined. Much like lottery winners after amassing huge profits, business sellers also tend to make regrettable decisions shortly after the transaction is completed.
Clearly, high-value business sellers have unique needs. But they are becoming less and less lonely. All types of clients can be equally idiosyncratic, so advisors must have the skills, relationships and experience needed to succeed in today’s conditions.
Ray Moell is Senior Director of Wealth Management at Choreo Advisors.