help your clients anticipate and prepare.
by anthony glomski
my years of experience helping successful entrepreneurs, combined with my research and interviews with experts in the area of successful business exits, have helped me to identify five key financial challenges that must be addressed by entrepreneurs who are planning to cash out of their businesses.
more: why and how to stress test client plans | three questions for clients who want to manage their own wealth | five experts your wealth management team needs | your client’s instincts are wrong
exclusively for pro members. log in here or 2022世界杯足球排名 today.
the objective is to help business owners make a smooth and successful transition from where they are today to where they want to be post-exit.
let’s look at five of the top challenges in more detail.
1. minimizing income taxes on the transaction. i don’t have to remind you about the importance of determining the likely tax exposure that a liquidity event will trigger for your client. you’ll also want them to avoid any unpleasant tax surprises and mitigate that tax bill as much as possible.
proactive, rather than reactive, tax planning can significantly reduce an exiting entrepreneur’s tax bill. consider that, without a plan, your client could pay more than 50 percent of their earnings (federal and state combined) in high tax states, such as my home state of california. if you take a few basic steps, you can reduce that tax burden to around 37 percent. and if you make all the right moves in advance of the transaction, the tax bill can fall below 30 percent. many entrepreneurs miss out on the qualified small business stock rule (qsbs) rule that could potentially eliminate 100 percent of the taxes paid. advanced planning can result in millions of dollars in taxes saved.
despite the significant impact that tax planning can have on an entrepreneur’s net worth, too many business owners (and their advisors) fail to plan around taxes effectively … or they don’t plan effectively enough. this should be at the top of your mind as your client moves toward liquidity.
there are tens of thousands of pages in the u.s. tax code. the rules and regulations pertaining to liquidity events are among the most complex on the books – even more so now, thanks to the tax cuts and jobs act (tcja) passed in late 2017 combined with massive economic and social uncertainty related to the covid-19 pandemic. i don’t need to explain the complexity to you. most owners don’t have the time or the patience to get deep into the weeds about the nuances of tax regs, nor will they be impressed by how much you know about the tax code. they just want to know what they have to do to get the best possible tax outcome pre- and post-exit. that’s where you can really shine.
you’ll also want to coordinate the work done on behalf of your client by a law firm that specializes in entrepreneurs who are approaching liquidity events, as well as the work done by other specialists such as derivative and valuation experts. with expert strategies, you’ll find smarter ways to maximize your client’s wealth and ensure ideal outcomes for your owner clients and their families. for example, if your client has stock options, they may want to take the steps to get the clock ticking on those options as early as possible. that way, gains from the sale can be treated as long-term capital gains instead of as short-term gains, thus potentially cutting the owner’s tax bill dramatically. the right professionals, such as specialized tax attorneys, offer wealth planning strategies that can mitigate millions of dollars in taxes. it’s your job to identify and coordinate your client’s relationship with those specialists.
2. maximizing wealth by not leaving money on the table. to get where they are today, a business owner had to make many smart decisions. their expertise about their business and entire industry may be unmatched. however, a liquidity event is a different beast entirely. it’s not something they do in the normal course of business and there are numerous ways that they can unwillingly leave money on the table.
say, for example, that your client is selling his or her company to a private equity firm. their job – their life – is to be great at their business. but the job of the private equity mbas sitting across the table from your client is to acquire companies at an attractive price. most likely, they simply know the world of acquisitions better than your client does. your client’s business might be selling software or construction materials; their business is buying businesses.
this imbalance can leave you and your client feeling uncertain or even fearful that you are not getting a deal that maximizes the entrepreneur’s value creation. at best, without proper planning, you’ll leave some money on the table. in extreme cases, transactions can fall apart entirely because the deal terms include risks that the business owners and their advisors don’t fully appreciate.
during my research, i interviewed many entrepreneurs who had successful exits from their businesses. one question i always asked was, “what is your biggest regret?” surprisingly (or not), some said exiting their business was their biggest regret. others said their biggest mistake was agreeing to a cap on their earn-out. by underestimating their own value, they ended up leaving a lot of money on the table.
i’ve discussed failure many times with entrepreneurs. in one case, a private equity firm came in with an attractive offer for the founder’s company. one of the deal terms was that the private equity firm would infuse capital in the short term, ramp up the company’s staff and incur additional overhead to lay the groundwork for expansion. however, neither the founder nor the private equity firm anticipated the dramatic shift in the economy that occurred at the time – the global financial crisis era of 2008-09. the severe recession caused the deal to fall apart and the business ultimately folded, largely because of the ill-timed expansion plans. similar sad stories are likely to play out often as a result of the covid-19 crisis and other black swan events that seem to come out of nowhere and rock us to the core.
3. preserving wealth by avoiding excessive single-stock risk. if your client’s business is being acquired by a publicly traded company, the deal may be done entirely by using the acquiring company’s stock. that means post-deal, the lion’s share of your client’s wealth will be composed of just one stock – the acquiring company’s – and your client will be incurring tremendous single-company risk from his or her lack of diversification.
the fact is companies can – and do – blow up unexpectedly. (remember fannie mae and freddie mac, “government-sponsored entities” that lost over 90 percent of their value?) when your client keeps the majority of their money in the shares of just one company – theirs – they risk losing enormous wealth in short order. having lived through the dotcom bust in san francisco, i unfortunately witnessed the carnage several times. take for example these dotcom darlings that crashed back to earth:
| high stock price | low stock price | % of wealth lost | |
| pets.com | $11 | $1 | 90% |
| webvan | $30 | $.06 | 99% |
| etoys | $84 | $.01 +/- | 99% |
one of the saddest examples of single-company risk occurred when media mogul ted turner lost $8 billion that he had concentrated in the stock of aol time warner. while turner remained a billionaire after that investing debacle, the aol time warner implosion had a devastating effect on turner, his family and the many philanthropic causes his family supported.
that said, addressing single-stock risk or single-company risk can be challenging. for one, your client is on the inside of their industry, which makes them confident about its major players and direction. this can be especially true if their company is acquired by an industry competitor. however, this perspective can lead to a false sense of security about knowing the future of the company and its stock. they may think they know the industry backward and forward and would be able to sense well in advance if something were about to go wrong. this knowledge might have been useful when the company was still private. however, once a firm becomes part of a publicly traded operation, your client and those he or she confides in can no longer use insider information to their benefit. even if they do have knowledge of impending negative news, they might not be able to share it, much less do anything about it. at times like these, entrepreneurs can be tempted to gamble with their financial health. it’s your job to prevent them from going down that road.
even very financially astute entrepreneurs can fall into the trap of being overly concentrated in a single stock. for years, they’ve had the bulk of their wealth tied up in just one asset – their company. so, after going through an exit or liquidity event, it seems logical that most of their wealth would remain concentrated in just a single stock (i.e., their company). that’s especially true if the stock of the acquiring firm is red-hot. your client doesn’t want to miss out on the gains if they sell or even trim back their holdings.
there is also a social-emotional issue at work here, as some entrepreneurs worry that they might appear to be disloyal (or that they are “going against the team”) by selling some of the shares they hold of the acquiring company’s stock.
it’s no surprise that you want them to diversify. however, holding a large basket of stocks is not the answer. major stock market corrections punish even the best of companies. instead, we recommend that exiting entrepreneurs hold a broadly diversified portfolio of assets that include not just different types of stocks and sectors, but other asset classes including fixed income, real estate, private equity, limited partnerships and investments in companies that they own and have some control over.
the bottom line: smart entrepreneurs preserve their wealth and let the gamblers gamble with theirs. next, we’ll explore how to ensure that successful clients transfer their wealth tax efficiently when it comes time and how to make sure their assets are not unjustly taken from them.
4. transferring wealth effectively and tax-efficiently. in the wake of a liquidity event, it is possible – even likely – that your client’s financial needs are well in hand. if so, they may be looking to ensure that their parents, children and grandchildren are well taken care of as well – and in accordance with their wishes and stipulations.
transferring wealth through estate planning requires you to decide how your assets will be distributed when you are gone. for successful entrepreneurs, this means determining how and when their heirs will receive money or business interests. it’s also about ensuring that the maximum amount possible is transferred to their heirs – while minimizing taxes. proper estate planning is the most effective way for successful entrepreneurs to leave a legacy for their loved ones in a way that satisfies their wishes and provides for the financial health and well-being of their family.
i’m sure you’ve seen clients endure years of stress when siblings and relatives attempt to sort out the estate of a recently deceased family member. the stress is even greater when substantial assets are involved, so make sure your entrepreneurial clients get their estate planning in order well before their exit takes place.
estate planning is one of the most important, yet misunderstood, areas of entrepreneurs’ financial lives. estate taxes, for example, usually receive all the attention, and it’s easy to see why: if they are not properly addressed, the government can grab 40% of what the entrepreneur has worked so hard to build.
that said, taxes are only one part of a broader estate planning picture. you and your client also need to focus on issues such as management and wealth succession concerns, selection of successor managers or trustees, and preparing loved ones to receive and make the best use of the money they will eventually inherit.
estate planning can become especially important prior to a liquidity event when the successful entrepreneur is likely to experience a huge increase in net worth. yesterday, an estate plan may have been the last thing on their mind. today, it becomes a top priority. even with a thorough estate plan in place, going through a liquidity event will create dramatic changes to his or her personal balance sheet and will limit the potential advanced planning opportunities available.
in short, estate planning is not a “one and done” exercise. the best estate plans are dynamic, living strategies that can be – and should be – adapted and optimized to reflect the changes that inevitably occur over the course of your life. make sure you are up to speed on the tax and accounting aspects of estate law in your state and be sure you have partnered with at least one, if not several, highly experienced estate attorneys to give your clients the best possible outcome pre- and post-exit.
5. protecting your client’s money from being taken unjustly. guarding one’s newly acquired wealth against potential creditors, lawsuits, children’s spouses, potential ex-spouses and catastrophic loss should be a key consideration. by historical standards, the number of lawsuits against the affluent in recent years is high. yet entrepreneurs rarely focus enough on protecting themselves. consider these sobering statistics from prince associates:
- approximately 65 percent of successful business owners say they have been involved in unjust personal lawsuits and/or divorce proceedings.
- roughly 90 percent of these business owners say they are concerned about such lawsuits.
- only about one in four business owners (26.9 percent) has a plan in place to protect his or her assets.
wealth protection strategies can be used to help safeguard wealth so that assets are not unjustly taken. these strategies will also provide your clients with greater peace of mind knowing that their financial security is indeed secure. how you address these concerns will depend on your client’s specific situation. common actions include controlling risks though restructuring various assets and considering legal forms of ownership – trusts, limited liability entities and so on – that put a shield between your client’s money and other parties that might not have their best interests in mind.
it’s critical to realize, however, that for asset protection strategies to be effective and able to withstand legal challenges, they must be put in place well before they are actually needed. the upshot: you need to plot out an asset protection strategy for your client plan sooner rather than later if you truly want to guard the significant wealth that your client has now (or is about to have).
creating a strategy
as you review the five key wealth-building challenges outlined in this post, think about the most successful entrepreneurs on your client roster. chances are many of them share these concerns – perhaps all of them. or maybe these are issues that they haven’t given much thought to in the past, and you’re now a bit closer to seeing how crucial it is to create a strategy that tackles them head-on.
the highest performing cpas i know are proactive rather than reactive. they don’t wait for clients to coming running to them with last-minute challenges and deadlines – they know how to anticipate them. when it comes to the successful business owners you serve, don’t let them get painted into a corner as they start contemplating an exit from their businesses. start the process several years in advance.
your response to the key wealth-building challenges discussed above – and others your clients may face – will be an enormous driver of the level of financial success and peace of mind that your client seeks as he or she moves toward liquidity.