The Liquidity Event: Seizing the Opportunity

A liquidity event is very uncommon—often a once in a lifetime success achieved after years of hard work and dedication. In fact, many entrepreneurs, concentrated stockholders or top executives can work their entire career without ever experiencing this type of event. As a result, many entrepreneurs find themselves underprepared emotionally and financially for the personal planning ramifications that often ensue as a result of a successful liquidity event. Recent changes in the 2018 tax rules also present challenges and opportunities to derive the best outcome.

Clearly, these events provide the shareholder with the potential to accumulate substantial wealth that is very often life-changing. But, at the same time, a liquidity event will produce new tax and legal obstacles foreign to all but the most sophisticated of investors and advisors. However, if properly planned for in advance, many of these new challenges can be minimized or eliminated altogether. The earlier you plan, the greater the range of opportunities.

“Keep in mind that planning early to reduce the effective tax rate on a potential transaction can be just as important as increasing earnings multiple to be used in the calculation of the selling price.”

The reality is, most entrepreneurs focus solely on running their business and handling transaction details, leaving personal planning issues to chance. This approach misses what is arguably the most important window of time to take action: before a liquidity event is realized. The knowledge of an experienced financial advisory team can help entrepreneurs make the right personal planning decisions before and after a liquidity event, which in turn allows for a more successful outcome.

“A liquidity event is generally defined as a substantial realization of wealth either via sale, merger/ acquisition, or IPO.”

A liquidity event, which includes the sale of a company or an initial public offering (IPO), requires vast amounts of time from leadership in two different but time-intensive roles: running the business and negotiating the numerous details of a successful transaction.

While resources are spread thin, it’s easy for attention and concern for personal finances to fall by the wayside. Pre-liquidity planning addresses these important considerations and defines end goals early in the process. In the book, The Seven Habits of Highly Effective People, best-selling author Steven Covey advocates as Habit #2 to “Begin with the End in Mind”. Just as an entrepreneur should plan ahead for the future of their business, so too should they plan ahead for their personal finances. Seizing the opportunity and beginning with the end in mind is precisely the objective of pre-liquidity planning.


Pre-Transaction Planning

Developing a Range of Outcomes, Aligning Goals

Sometimes there are discrepancies between cash flow needs and what the liquidity event will provide. For example, an IPO might result in tens of millions of dollars, but those funds might not be immediately accessible. In fact, the ultimate realization of wealth in an IPO could take years to realize. A simple rule of thumb, until the stock is sold and taxes are paid, it’s not spendable money.

In the case of an acquisition event, whether for stock or cash, the outcome becomes a bit more certain but it is still important to gain a better understanding of the fundamental value of money today versus money in the future. For example, what is the potential growth of the monies received, and can the individual truly be financially independent?

During the pre-liquidity planning stage, a full-blown forensic view is taken to understand what cash flow is required to fund lifestyle, what monies are accessible today, and what monies will be accessible in the future. Detailed questions are asked to understand where the individual would like to be financially and to account for any potential tax ramifications of the liquidity event. Coordination between key advisors is a challenge, particularly if tax and investment counsel aren’t working together to find solutions. Sarian Strategic Partners leads this process and ensures that the details are taken care of — from start to finish.

Owners and executives often inquire about the best time to plan for a liquidity event. The answer is simple: the sooner the better. Once a transaction is finalized, changes can no longer be made, choices are limited, and tax ramifications are generally locked into place. The recent trend towards higher taxation for high income earners places an even greater value on planning early. Individuals undergoing a liquidity event can generally expect to find themselves in the highest tax brackets for many years. In some circumstances, marginal tax rates could even exceed 40 percent!


Tax Planning Strategies to Consider

What is an 83(b) Election?

The 83(b) election is ideal for founders or executives who receive stock in an early stage company, who believe the company will experience significant appreciation. The 83(b) election allows you to decide when you receive shares at the start of a vesting period to be taxed for the entire amount that will eventually vest. Instead of paying taxes annually, you pay all the tax up front at the full market value on the date of grant. It is critical however, to make this election within 30 days of the stock grant being made. The tax usually is ordinary income based on the valuation of the stock less the amount paid for it. When the election is made in this timely, 30 day period, the clock begins to tick for long-term capital gains treatment.

Why is it Beneficial?

Simply put, 83(b) election is an exercise in confidence that the value of the new company is going to increase in value. If this is in fact the case, you paid tax early at low or no value, and when the company grows, you can sell shares held more than a year at a long-term capital gain rate. Even at the highest marginal income tax rates, this is a benefit. The highest marginal income tax rate for a married couple filing jointly is 37%. The highest capital gain rates plus health care tax is 23.8%. Even at these highest rates, the tax savings between the long-term capital gain rate and the ordinary income rate can be significant. From the issuing company’s perspective, the 83(b) election causes an acceleration of both the employee’s payment of taxes and the employer’s deduction of the compensation expense.

Income Tax Planning Considerations In Light of New 2018 Tax Rules

The tax law changes of 2018 marked the most significant change in the income tax rules in over 30 years. While there is a slight reduction in the tax rates leved at the higher levels, the cap of $10,000 on the combined state income tax and property tax removes a significant portion of the benefit of the lower rates. Capital gain rates as well as the tax on the new investment income also remain intact, keeping the highest capital gain rate at 23.8%. The highest marginal income tax rate is 37%.

Family Gifting Strategies

If you have transferable equity ownership in an entity, these shares can be gifted to loved ones. An individual can gift up to $15,000 per recipient, per year, without exceeding the annual exclusions. If this is done in advance of a transaction, the tax liability at the transaction may result in a lower rate of capital gains tax. For single tax filers under $38,600 of income including the gain there is 0% capital gain and under $260,000 of income including the gain, the capital gain tax rate is 15% and for married tax filers the amount are $77,000 and $250,000 respectfully.

Leverage Annual Gifting and the Lower Capital Gains Rate

In past years, parents and grandparents may have considered gifting appreciated assets to children and grandchildren to take advantage of the potentially lower capital gains rates when these assets are sold (note that the donor’s cost basis is transferred with the stock). Those who may be in the two lowest brackets—10% to 15%— and subject to the 0% capital gains rate in 2019 may be appropriate recipients. Children subject to the “kiddie tax” ($2,100) who may pay tax or the trust/ estate rates, may be less appropriate recipients.

Pay Certain Expenses Directly

Unlimited payments for qualified medical and educational purposes can be made on behalf of another person without generating gift tax, enabling investors to accelerate their gifting strategies. These gifts must be made directly to the respective medical or educational institution to qualify for exclusion.

Estate Tax Considerations

There are significant changes in wealth transfer for 2019. This includes the ability to pass $11,400,000 per person and $22,800,000* per married couple free of estate tax (*as of 2019 with a six year sunset). After that exemption, upwards of 40 percent could be exposed to federal estate taxes. The state of Pennsylvania still levies a 4.5% to heirs, 12% to siblings and 15% to others.

While the theresholds have increased, one should still consider the affect of compounding on the growth of a nest egg. For example, even a modest 3 percent compounded annual interest rate could take a $20 million estate to $48,545,249 over 30 years.

Fortunately, advanced strategies can be leveraged so that growth is sheltered from estate tax. Some of the more popular strategies include Grantor Retained Annuity Trusts (GRAT), Intentionally Defective Grantor Trusts (IDGT), and Charitable Remainder Trusts (CRT). Through early planning, a wide variety of tools are available to preserve wealth and minimize tax ramifications.

It’s also important to consider the potential benefits of life insurance as a mechanism to restore an estate subject to taxes and preserve the value for heirs. For example, for estates greater than $22 million, the business owner may decide to establish an Irrevocable Life Insurance Trust (ILIT) to hold permanent insurance designed to pay a certain benefit amount to heirs, free of estate tax. Based on the goals of the family, insurance strategies can be used to replace the value lost from taxes, ensuring that hard earned wealth is transferred in full to future generations.

Grantor Retained Annuity Trust (GRAT)

A GRAT allows the owner to transfer assets in exchange for an annuity. The annuity is payable over a specific period of time and the annuity amount is calculated so the present value is equal to the value of the property placed in trust. As a result, no gift tax is due. Present-value calculations are based on the IRS prevailing interest rate. When stock is transferred and it appreciates in excess of the annuity amount, the excess amount remains in trust for the beneficiaries and is transferred free of gift and estate tax.


Public Equity Transaction Planning

Stock options should be evaluated before a liquidity event takes place. For example, compensatory stock options can be a large asset for executives and owners, presenting some interesting challenges during a liquidity event. Individuals may eventually want to exercise options or liquidate shares, which will trigger tax exposure. Here are some important considerations.

Non-Qualified Options (NQ)

The spread between a stock’s fair market value and exercise price is treated as income when an executive exercises non-qualified options. This spread is taxed based on the individual’s tax bracket and is subject to employment taxes and withholding. Depending on the holding period, gains or losses after the exercise of the option may be treated as short-term or long-term capital. At exercise, the executive has two choices: they can simultaneously exercise and sell the shares, or they can choose to exercise and hold the shares for some period of time. If the shares are held more than 12 months after an exercise and hold strategy, any gain would be treated as long-term capital gains instead of ordinary income. For owners who find themselves in the maximum tax bracket, the tax savings could be substantial to exercise early and hold for capital gains treatment.

Incentive Stock Options (ISO)

Executives who meet holding-period requirements may benefit from additional tax advantages because compensation income is not produced upon exercise. Although ISOs may be subject to the alternative minimum tax (AMT), executives can later claim credit for the paid AMT. The credit amount depends on income and deductions in later tax years.

To further illustrate why it is also important to consider early exercise of stock options, we can look at a simplified example. Let’s say you have an option at $1 per share. After five years, you exercise and sell at $5 per share—worth $5,000 total. When you sell, you pay taxes on the full $4 spread at your ordinary income rates—losing 40 percent or more of the value to taxes.

Instead, let’s say you had planned ahead and decided to exercise at $1.10 per share and pay taxes on the $0.10 spread—which is a minimal amount. When the stock reaches the same $5 per share price, you sell it. Since you’ve held the shares for more than 12 months, long-term capital gains tax is assessed on the spread instead of the income tax rate, generating a significant tax savings. In fact, depending on how much stock is owned, this could amount to hundreds of thousands of dollars in tax savings by addressing options before the liquidity event occurs.

Restricted Stock Units (RSU’s)

RSU’s are another way an employer can grant equity participation to an employee. The grant is restricted because it is subject to a vesting schedule. You receive the shares at the vesting date at which point they are always taxable and ordinary income. If you hold them past vesting, future appreciation is taxable as capital gains.

IPO Event

Once a company goes public, shareholders will be subject to lockup, which is an agreement between the business and investment bank taking the organization public. The agreement states that shares cannot be sold within a specific period of days after the IPO event, usually 180 days. Once the contract is fulfilled and the lockup has expired, shares are generally free to be sold in the marketplace.

Most of the strategies articulated in the preceding “stock deal” section are available at this point. For example, stock can be sold or hedged, or a monetization collar strategy can be used. Executives should also consider diversifying concentrated holdings and strategies focused on minimizing current taxation.

Without a 10b5-1 plan, owners are confined to selling or transacting company stock during “open windows.”

10b5-1 plans

Without this type of plan, owners are confined to selling or transacting company stock during “open windows.” This is typically three business days following an earnings announcement. To manage these rules and restrictions, some executives opt to use a 10b5-1 plan. These plans are filed with the SEC and include a stated-in-advance program with which the officer establishes some metrics inside the plan before relinquishing control. The plan is essentially on autopilot—with a trader associated with the selling system —generally based on price, number of shares and/or certain dates. Once these items are established, they should not be modified. Modification is only possible if it’s allowed under the insider trading policy of the company and the holder is within an open window.

10b5-1 plans must be adopted during an open window and generally have a cooling-off period of anywhere from two weeks to 90 days.

Insider Trading Policies

After the transaction is complete, an understanding of insider trading policies becomes important. This can include restrictions on how stock is sold and whether hedging is allowed. An experienced advisor can help the owner navigate concerns and questions involving corporate insider trading policies.

Liability Management

The use and tax implications of debt before and after an event are also key in the planning process.

Our analysis of debt involves both the after tax cost of the debt versus a low risk investment, as well as the qualitative goal that often follows a liquidity event about being debt free. This is especially important now as the 2018 tax laws cap the deductibility of mortgage debt at $750,000. In viewing your mortgages, home equity lines of credit and student loans from these two perspectives, we can come back to you with guidance and clarity about paying down the debt entirely.


Post Transaction Planning Strategies to Keep More of What You Have Built

While it’s true that more opportunities exist during the pre-liquidity planning stage, there is still plenty to accomplish after the transaction is complete. The best approach depends on the type of transaction— such as the all-cash deal, stock deal or IPO event— and the actions taken before the liquidity event.

All-Cash Deal

An all-cash deal may limit some of the planning opportunities; however, there are still opportunities to shelter wealth from taxation. For example, in cases of closely held businesses, there can be significant value in evaluating the ownership structure of the business. Depending on the potential exit, it can make sense to re-organize in advance of a deal. In cases where this is not an option, taking advantage of retirement and deferred compensation contributions can be leveraged to protect wealth and drive down taxable income. Individuals should also consider any charitable inclinations, such as establishing a Family Foundation or Donor Advised Fund, Charitable Remainder Trust or outright gifts to charity.

These strategies serve a dual benefit because they can provide a significant tax benefit while at the same time accomplishing a social benefit to the donor and his or her designated charities.

After the liquidity event, advisors can also evaluate how money is being held to limit tax exposure. For example, investors may qualify for special tax treatment on capital gains tax under section 1202 of the IRS code. Additionally, there may be capital gains exemptions available for deal proceeds used to purchase another qualifying small business.

Stock Deal

For a stock deal, it’s important to understand the ramifications of holding stock that is now public. Evaluations of private companies are infrequent and the shares are generally illiquid, but that changes when the company becomes public. A public company becomes subject to daily valuations—and because of this, fluctuations in net worth will be substantial. Therefore, a decision must be made about how much stock to hold and how much to sell. It’s a difficult balance to strike when evaluating the desire to preserve hard earned wealth but maintain participation in the upside of the business. However, not diversifying the shares when given the chance could be a significant mistake. Proper planning will help to mitigate this risk.

Accelerate Contributions to a 529 Savings Plan

While traditional gifting strategies are limited to $15,000 per recipient, per year, $30,000 as a married couple, the 529 has a special caveat. In any one year, you can accelerate up to five years of gifting, up to $150,000 for a married couple. This can provide a modest PA state income tax deduction and the account grows on a tax free basis if the funds are used for higher education purposes, and $10,000 per year for secondary schools.

Philanthropy & Tax Planning

Many entrepreneurs are already active in charitable endeavors, so philanthropy can be an appealing strategy for offsetting tax liabilities. If they have significant assets that they are inclined to donate, they can set up a private 501(c)(3) foundation, which enables them to direct gifts to religious, educational, scientific and other types of charitable organizations. With, for example, a $3 million inflow from their sale, they could place $500,000 into a family foundation. This would reduce their taxable income and provide a pool of money from which to draw for future donations.

If the amount they have for philanthropy is smaller, they can contribute to a donor advised fund. These are funds housed and administered by a public charity and created for the purpose of managing charitable donations on behalf of a family or individual. Donors only advise the sponsoring organization where the money should go but they receive the maximum tax deduction available, while avoiding excise taxes and other restrictions imposed on private foundations.

Donor Advised Funds

A donor advised fund is a helpful tool for smaller contributions to public charities. This is a vehicle offered by many financial institutions that can receive contributions of cash or securities. The donor receives a current year income tax deduction but has many years to distribute to qualified charities. The donor advised fund can be funded up until December 31st in the year of the transaction and provide a bucket for future charitable giving.

Charitable Remainder Trusts (CRT)

CRTs are a common tax-deferral technique—especially with investors focused on combining charitable giving with tax-deferred diversification. The CRT pays an annual distribution to a beneficiary. When the CRT is established, the donor receives a charitable donation deduction that is equal to the present value of the charity’s expected remainder interest. All income earned by the CRT is untaxed until distribution to the beneficiary occurs.

The holder of stock can sell the shares, not pay capital gains and re-invest the whole amount of the proceeds into a diversified portfolio. The diversified portfolio will remain in trust and income will be distributed annually to the donor. At the end of the trust term, or the donor’s life, whichever option is selected, the remainder value will pass to the charity or charities of the donor’s choice.

Pennsylvania Education Improvement Tax Credit (EITC) Program

The Educational Improvement Tax Credit Program allows businesses to support financial aid for educational organizations and fulfill their state tax burden. Through this program, businesses can receive a 75% state tax credit or a 90% state tax credit (if business makes a two year commitment) of its contributions per year. Many independent secondary schools have credits that you can access to take advantage of this benefit

Risk Management

While your asset base is illiquid, there is a greater need for inexpensive term life insurance and long term disability protection that will provide an income stream if you are unable to work when your asset base is more liquid and you become “self-insured.” Your life and disability insurance may decline by you should consider umbrella protection. An umbrella policy is obtained through some insurance vendors as your home owners and sits on top of your replacement coverage to protect your asset base against litigious actions.



A liquidity event is a milestone of success. Owners and executives work hard to build a business, and closing a transaction brings that hard work full circle. Moving forward, individuals should continue to reassess and monitor strategies executed before and after the liquidity event, to ensure that the strategies are performing as expected and to make any necessary adjustments to reflect changing goals and plans for the future.

Regardless of your stage in the process, whether it’s pre-liquidity, post-liquidity or somewhere in between, HighTower can lead the process to ensure that all the important details are taken care of—from start to finish. For more information, please call Sarian Strategic Partners.


Fiduciary Standard

First and foremost, HighTower has a fiduciary relationship with each client. Putting your interests first and providing objective advice and solutions is more than just a mission statement – it is our duty.

We use an investment process that is fully supported by our own independent research, due diligence and investment decision-making. HighTower’s capital partners have no direct interest in or involvement with our investment management, which eliminates many of the conflicts of interest found at traditional brokerage firms.