Business Owners Focus
Private Wealth Management
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Welcome to William Blair’s Business Owners Focus. Below, you will find a series of articles for business owners, addressing the options of selling your business or completing a dividend recapitalization. The journey starts with must-know steps and is followed by a closer look at the benefits of each process, questions to ask before you sell, and more.
Advisory Team Selection
Should I Hire an Advisor to Help Sell My Business?
Selling a business can be a complicated process, and the potential buyers on the other side of the bargaining table usually are very sophisticated. It is important to have a team of trusted advisors with extensive experience managing these processes and representing companies in your industry.
What Documents and Information Are Required to Sell a Business?
At a formal kickoff meeting between the investment bankers and the owners, the team will start brainstorming about which type of buyers will have the most interest, when to launch the marketing process, how to position the company for maximum value, and what questions or concerns will come up during due diligence.
How Can I Find a Buyer for My Business?
This is the point when the investment bankers will begin reaching out to potential buyers to let them know that the company is available for sale and to gauge their level of interest.
How Do I Answer Business Buyers’ Questions?
The investment bankers will determine which bidders will be invited to dig deeper to determine how much they would be willing to pay for the company.
How Do I Choose the Right Buyer for My Business?
After the potential buyers have completed their due diligence, bidders will be asked to present their best and final offers.
What Happens While Finalizing the
Business Sale Transaction?
Once the winning bidder has been selected and the final details have been negotiated, the final steps involve signing the transaction, receiving the funds, and passing regulatory review.
Getting to the finish line: Once the final agreement has been negotiated and signed, it becomes a binding contract.
Funds transfer: After the signing, typically there is a 15- to 30-day delay before the funds transfer to the owner’s bank account.
Regulatory review: During this period, larger transactions will be reviewed by the Federal Trade Commission for compliance with anti-trust laws, and the buyer may be completing its financing arrangements.
Team composition: The team may include investment bankers, attorneys, accountants, wealth planning specialists, and analysts who perform quality of earnings reports and market assessments.
Take the lead: In most cases, an investment bank should be selected first because the investment bankers will lead the process and other advisors. The investment bankers can guide the sellers through the process of deciding 1) which type of transaction will be the most effective and 2) the timeline for pursuing a sale.
Involve your wealth advisor early: By Step 2, business owners should begin discussions with their wealth advisors about strategies that may be used to minimize the taxes related to the sale and to achieve the owner’s long-term financial goals. These discussions should include a review of the owner’s estate planning documents, and should cover topics such as income tax implications of a transaction, wealth transfer and gifting objectives, and risk management.
Marketing materials: Investment bankers will begin drafting the slide decks, financial models, confidential information memorandum, and other marketing materials that will be used to tell the company’s story to the universe of potential buyers.
Data room: The investment bankers will begin creating the data room, which is a repository of financial statements, contracts, and other important documents that potential buyers who have signed non-disclosure agreements will be given access to in the due diligence phase.
Quality of earnings: A third-party firm will begin creating a quality of earnings report, which is a forward-looking analysis that attempts to strip out irregularities related to taxes, currency movements, and one-time events, and measure the company’s ability to generate sustainable profit.
Timing of outreach: Rather than reaching out to the entire universe of potential buyers at once, the investment bankers may decide to stagger the timing of when companies are contacted. This strategy, which is based on the investment banker’s knowledge of individual buyers’ aggressiveness and past behavior in deal processes, can be helpful in creating a dynamic where the most interested buyers are able to stay involved until the final stages.
Non-disclosure agreement: Interested parties will sign a non-disclosure agreement (NDA) and then receive the marketing materials. The NDA is used to ensure that any trade secrets in the marketing materials are not used to adversely affect the seller’s business.
Indication of interest: The interested parties will then submit an indication of interest (IOI), which outlines the range of prices that they would be willing to pay for the business and the assumptions they used to arrive at those prices.
Evaluating IOIs: Upon reviewing the IOIs, the investment bankers will determine which bidders will be invited to conduct their due diligence on the company. An experienced investment banker will have insight into which potential buyers are most likely to make it to the finish line with a final offer at the higher end of their IOI range.
Hosting management presentations: During the management presentations, potential buyers will meet with executives of the selling company to ask questions about the business and get to know the leadership team better.
Granting access to the data room: Potential buyers will be given access to the data room, allowing them to review details of employment contracts; customer, supplier, and vendor contracts; insurance policies; and other documents that contain important details about the company’s operations, legal obligations, and financial background.
Follow-up meeting: Many potential buyers will ask to hold follow-up meetings with the executives to go over any questions that arise when reviewing the data room.
Best and Final
Reviewing the purchase agreement: In addition to giving a specific purchase price, the final offer will include a purchase agreement that stipulates details, such as how the purchase payments will be structured and financed, whether members of the seller’s management team and other key employees will be required to remain with the company, and whether the sellers will be able to participate in the continued growth of the company via rollover equity contribution.
Selecting the winning bid: At this point, the owners and their team of advisors will be able to determine which bidder will make the best partner for the company. While price is certainly a major consideration, it is just one of many factors that need to be evaluated. Whether the bidder is a good fit culturally can make an enormous impact on the success of the company post-acquisition. The owners will also want to understand the bidder’s plans for the company and how those could affect the company’s employees. Other important non-price considerations include the timing of the closing and the degree of certainty that the bidder will make it to the finish line.
Assessing the tax consequences: The owner’s wealth advisors should review the purchase agreements to determine what portion of the transaction will be treated as ordinary income vs. capital gains.
Signing and Closing
Learn more about this process
Understanding Business Sale and Dividend Recap Process
William Blair is here to guide owners of family or other closely held businesses through the big decisions.
Learn how to get started
We recognize the importance of working with your advisors to turn your hard work into an enduring financial legacy.
Turning Your Wealth Into Enduring Legacy
Learn more about what to consider
When you determine whether you are ready for a liquidity event, there are personal and financial questions to consider.
Considerations for Every Entrepreneur
BUSINESS OWNERS FOCUS
William Blair is here to guide owners of family or other closely held businesses through the big decisions, such as evaluating liquidity options as you consider next steps. We know that for business owners, the stakes are high—from both a financial and an emotional standpoint—so trusted expertise is essential as you take the next steps.
Thinking about selling or a dividend recap?
To learn about preparing for a liquidity event, download our full guide: Understanding the Business Sale and Dividend Recap Process
Download the guide
Distribute the offering memorandum and marketing materials: For debt transactions, the universe of potential lenders includes banks, private credit funds, and specialty lenders. For equity transactions, the universe of potential investors includes private equity funds, family offices, and pension funds.
Evaluate the bids: With a debt transaction, terms to consider include interest rate, covenants, repayment restrictions, and length of the loan. With a sale of minority equity, terms to consider include the valuation, type of equity, voting rights, and board seats, as well as whether the investor can bring valuable management expertise to the company.
Negotiate final terms and select the winning partner: Once the parties have completed their due diligence, the investment bankers will negotiate with them to secure their best and final offers, and a winning bid will be selected.
Close the transaction: Once the final documents are signed, the funds will be distributed to the company and then to the owners in the form of a special dividend or share purchase.
It is important business owners/entrepreneurs determine the amount of capital they are looking to raise and whether a debt recapitalization or equity recapitalization is most appropriate. If you are the owner, you must think about how much control and upside participation you are willing to give up, as well as how much leverage lenders are willing to offer and how much debt the company can add to its balance sheet. Following are more steps to consider in a dividend recap.
What Are Steps in a Dividend Recap Process?
A dividend recapitalization for a business involves borrowing money or selling a minority share of the company’s equity, and using the proceeds to pay a one-time dividend to the owners. In what cases would a company decide on a dividend recap? This option has many of the same elements as the process for selling a company, but benefits of a dividend recap include the fact it can be completed in a shorter timeframe. As with a sale, in a dividend recapitalization, the investment banker’s role is to facilitate an efficient process, clear the market by identifying all of the most interested potential lenders or investors, and secure the most favorable terms possible for the business owners.
What Is a Dividend Recap for a Business and How Does a Dividend Recap Work?
To learn more about preparing for a liquidity event, schedule a time to talk with a William Blair advisor.
Contact an advisor
If you are a business owner, you may have considered selling your business or recapitalizing, immediately or in the future. You might want to realize greater wealth, or gain liquidity to reinvest or use for new projects. You may want to separate value from control as part of your wealth transfer planning. Your reasons are as unique as you are, and important to what comes next.
However, completing a business sales process or a dividend recapitalization is no small task. These are complicated processes with multiple steps and require coordinating a number of professionals. The right advisor can help. So can reviewing best practices to ensure you understand the journey ahead.
We have outlined below a brief “business for sale” process, followed by dividend recapitalization information built by the expertise of professionals at William Blair. The opportunity to be acquired or to generate liquidity can be both exciting and overwhelming, and the stakes are high—from both a financial and an emotional standpoint. We help guide owners of a family business or other closely held business through these monumental decisions, working together to evaluate the options available to create liquidity.
What Happens When Selling a Business? What Steps Are Important?
A sale, also known as a merger or acquisition, involves selling all or a portion of the company’s shares to a strategic buyer or a private equity firm (also referred to as a “financial sponsor”). In your case, the company up for sale may be owned by you the entrepreneur, or it may be a family business, or one with multiple, unrelated owners.
For business owners considering selling a company, it is important to understand the various steps of a sale process. Click below for each step.
Selecting an advisory team
Understanding how to prepare
Marketing your business
Reviewing the offers
Completing the final steps
What Happens While Finalizing the Business Sale Transaction?
Although timing can vary significantly, it often takes 12-24 months from when an advisor is hired to when a transaction is completed. In a mergers and acquisitions (M&A) environment where buyers have become increasingly aggressive in their pursuit of high-quality companies, these timelines can be even shorter.
How Long Will It Take to Sell My Family Business?
How Do I Sell My Business… or Complete a Dividend Recapitalization Process?
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Fueled by low interest rates, conditions for selling a business or completing a dividend recapitalization have been generally favorable for owners over the past several years. Each approach carries a unique set of pros and cons; understanding both is critical to the process of gaining liquidity.
Side-by-Side Comparison of Business Sale and Dividend Recap Processes [infographic]
Typical timeframe for completion
Opportunity to participate in future growth
(after investment bank has been engaged)
Limiting factor for amount of capital that can be raised
Impact on management control
Timing of liquidity
Impact on company's future performance
Impact on succesion planning
Majority received upon closing less earn-outs, rollovers, and vesting provisions
Buyer's valuation of the company
Owner's willingness to give up equity and investor's valuation of the company
Current owners retain control
Transfers to buyer
Limited to rollover equity
Depends on buyer's plans for the company
May negate the need for finding a successor
Company's ability to take on additional debt and lender's willingness to lend
Current owners typically retain control, but investors usually have voting rights and receive board seats
Debt payments may make company more vulnerable to business downturns; covenants may limit the company’s operating flexibility
Received upon closing
100% retained by owners
Investors may be interested in expanding ownership stake and taking management control
Retained by owners but reduced by the amount of equity sold
You may be considering selling your business or recapitalizing to realize greater wealth or increase liquidity. But which approach will work best for you? Following are key considerations for each.
Your Business for Sale—What to Expect
When evaluating whether selling your company is the appropriate path to pursue, you as a business owner should think about the following.
With an equity recapitalization, which may also be referred to as a minority sale, your equity would be reduced by the amount sold to outside investors. With a debt recapitalization, you as the business owner would retain 100% of the equity ownership. (See definitions of dividend recapitalization, and equity and debt recaps)
Pros and Cons of a Dividend Recap
What to Consider When Deciding to Sell or Recapitalize Your Business
(See definitions of dividend recapitalization, and equity and debt recaps)
Strategic buyers could be larger companies in your industry, similarly sized competitors, or companies in adjacent industries.
Often the buyer—especially when it is a private equity firm—may request, or even require, that the previous owner stays involved in the business, either in a management or advisory role.
Buyers may require sellers to “roll over” a portion of the sale proceeds as an equity stake in the acquiring company.
There may be an “earn-out” component to the seller’s compensation, where a portion of the sale proceeds are paid up front, and the remainder is paid when/if the company meets performance or timing goals post-transaction.
An outright sale may be an attractive option for a company whose owner is getting ready to retire and has no likely successor.
Dividend recapitalizations can be an effective way for owners to “take some chips off the table” while retaining control of the company.
In the case of an owner who wants to run the company for an extended period and believes that the company has significant growth opportunities over the next several years, a recapitalization exit strategy allows the owner to cash out some of his or her equity and still participate in a sale down the road (i.e., “take a second bite of the apple”).
Dividend recapitalizations can also work well in situations where some family members want to retain ownership of the company while others want to liquidate their positions.
Not every company is a candidate for a debt recapitalization because taking on the additional debt could hurt the company’s future performance. But for companies that have relatively low levels of debt, have a history of consistent profits and cash flows, and operate in industries with low cyclicality, a debt recapitalization may be an appealing option, especially when interest rates are low.
When it comes to structuring the proceeds of a transaction and managing the wealth created by selling your business or completing a dividend recapitalization, the earlier you begin planning, the better.
How a transaction is organized can have a significant impact on the after-tax wealth generated for you as the owner. It is important to work with an advisor who has experience helping owners structure transactions in a way that limits the proceeds’ exposure to income taxes and eventually estate taxes.
Personal Financial Planning for Business Owners—Frequently Asked Questions (FAQs)
Well before a transaction closes and the funds are received, you should begin working with your wealth advisor to think through the following questions.
Be Sure to Think About Personal Wealth Well Before a Liquidity Event
How does my business structure affect my overall planning (or) a future liquidity event?
It is a good idea to consider personal planning considerations around a liquidity event well in advance—even when you are initially establishing your business structure. The right business formation for you may be a C-Corp or an S-Corp. For example, a C-Corp (in which the owners or shareholders are taxed separately from the entity) may allow for the ownership of Qualified Small Business (QSB) stock. Among other benefits, with QSB stock, you may be eligible to eliminate tax on all or a large portion of your gain when you sell—up to 10x cost basis points or $10 million. In the case of an S-Corp (this structure passes corporate income, losses, deductions, and credits through to shareholders for federal tax purposes), you can benefit from a 338(H)(10) election. A 338(H)(10) is a tax election that re-characterizes a stock purchase as an asset purchase. This allows for asset depreciation and other benefits. It is important to engage your wealth advisor to help you understand and make decisions about how business structure can have a meaningful impact on your personal wealth planning.
For most business owners, a sale or dividend recapitalization will elevate them to a new level of liquid or financial wealth and open a wide array of new possibilities. Before developing a plan for personal wealth management, you should identify what your priorities are and what you would most like to achieve in light of these new opportunities.
What are my goals and priorities for selling my business?
The character of the income from a transaction will have a significant impact on the overall tax exposure for you as a business owner. The top federal long-term capital gains rate is 20% plus potential exposure to a 3.8% tax on investment income. In contrast, the top federal rate for ordinary income is 37%. In most cases, rolled equity can be shielded from tax at the time of the transaction and may qualify for long-term capital gain treatment when realized. It is also important to understand elements of a purchase agreement that affect the ultimate value and the timing of the liquidity, including carried interests, performance-based options, vesting, and earn-outs.
How can I avoid capital gains tax on a business sale?
A liquidity event often creates opportunities to pass wealth on to younger generations, so you should work with your wealth advisors to evaluate whether the current estate plan will adequately handle the new wealth created by the transaction. Depending on your goals, and your overall wealth, it may be advantageous to establish trusts to shift portions of your equity well in advance of a transaction.
Do my estate planning documents need to be updated before a liquidity event?
You can work with your wealth advisor to develop a comprehensive financial plan that addresses any large one-time purchases that you as an owner would like to make. You may also want to replace income that you would have previously earned from your business. Your wealth advisor can recreate a “paycheck” from a portion of the after-tax proceeds. The plan also needs to take into account the potential value of any equity rollovers and earn-outs.
What will my cash-flow needs be after the transaction?
If you are looking to transfer wealth to younger generations and believe that the company will sell for more than its current valuation, you may want to transfer shares to a trust for children or grandchildren well before the agreement is finalized. Taking advantage of the pre-transaction valuation discount effectively increases the amount that can be passed to younger generations without being subject to gift or estate tax. You may also consider a GRAT, a grantor retained annuity trust, which minimizes taxes on large financial gifts to family members. Be sure to work with a wealth advisor to plan well in advance of selling your business, so you can reap the benefits of these and other planning strategies.
What are smart ways to transfer wealth?
Being proactive in implementing wealth-transfer or charitable strategies can help avoid running afoul of assignment of income principles that, if violated, could cause you as the owner to pay income tax on the contributed shares.
How do I avoid assignment of income issues?
Sale proceeds can be used to fund charitable vehicles, such as donor-advised funds, private foundations, charitable trusts, or outright gifts of stock, that generate a tax deduction for the donor. There may also be an opportunity to establish charitable vehicles ahead of a business sale or transaction that can avoid or reduce exposure to capital gains tax. Accelerating the donations into the year of the sale can help offset the taxable income generated by the sale of the company.
How can I achieve the most strategic approach to philanthropy?
If you as a business owner are going through the process of selling your business or completing a dividend recapitalization, your advisor will have experience guiding you through the process of developing a plan for managing the liquidity generated. The table below shows how an owner’s personal financial planning aligns with investment banking process.
How Personal Wealth Planning Aligns with the Business Sale Process [infographic]
Investment Banking Goals
Private Wealth Management Goals
Building a team of trusted advisors
– Investment bankers
– Consultants for quality of earnings reports and market assessments
Find an advisor with experience guiding business owners through liquidity events and structuring transactions in a tax-efficient manner
– Identify goals and priorities related to new wealth
– Begin assessing tax consequences of potential transactions
– Identify opportunities to minimize transaction proceeds’ tax exposure
– Review estate planning documents
– Implement wealth transfer strategies to take advantage of valuation discounts and to avoid assignment of income
Gathering information for potential buyers
– Determine outreach strategy and timing
– Draft offering memorandums, pitch books, and financial models
– Begin creating data room
Contacting potential buyers
– Send marketing materials to universe of potential buyers
– Collect non-disclosure agreements
– Review initial indications of interest
Answering buyers’ questions
– Determine which bidders are invited to next round
– Conduct management presentations
– Give access to data rooms
– Analyze final offers in terms of tax consequences, earn-outs, rollovers, vesting, and timing
– Establish proceeds account and escrow account for taxes
– Implement comprehensive wealth management plan—including short-term interest strategy for taxes, funding wealth transfer, and charitable vehicles—and begin portfolio deployment
Choosing the right partner
– Review final offers and purchase agreements
– Determine which offer is the most attractive in terms of price, certainty of
close, and cultural fit
Best & Final
Finalizing the transaction
– Sign final documents
– Clear anti-trust review
– Transfer funds
Signing & Closing
The most critical decisions about selling your business are the ones made well before any potential buyers have been contacted. Achieving a high valuation and minimizing taxes certainly matter. But these issues are secondary to answering questions about what you are ultimately trying to accomplish—for the company, yourself, and your family. The answers to these questions are vital in determining whether a transaction makes sense for you. It is important to be working with a wealth advisor at this point to help you think through the implications of what you discover in this exercise.
For businesses with multiple owners, it is also important all owners think through these questions. By understanding each party’s goals and identifying potential conflicts, owners and their advisors can better create a strategy for an optimal outcome.
Here are 10 questions to consider before selling your business:
10 Questions to Ask Yourself Before Selling Your Business
Download our full guide on Understanding the Business Sale and Dividend Recap Process
1. What is my motivation for pursuing a transaction? (What am I looking to accomplish?)
2. What are my goals from a personal wealth planning perspective, in terms of retirement, transferring money to younger generations, and philanthropy?
3. What level of assets and liquidity are needed to achieve those goals?
4. What are my goals for the future of the company?
5. When am I looking to generate liquidity?
6. Where is the company in terms of its life-cycle and future growth opportunities?
7. How will the transaction impact our employees and our community?
8. Do I want to stay involved in running the company post-transaction? (Do my family members and younger generations want to be involved in the company going forward? Are there potential successors?)
9. How much longer do I want to be involved in managing the company?
10. Am I emotionally prepared to transfer some or all control of the business to an outside equity partner? (If so, what characteristics am I looking for in a potential investor or partner?)
Download our full guide on Understanding the Business Sale and Dividend Recap Process
At William Blair, we recognize the importance of business owners working with their wealth advisors to turn all that hard work into an enduring financial legacy. Assembling a coordinated team of advisors is essential to achieving a coordinated approach to planning. There are many vehicles and methods that business owners can use to maximize impact, and each approach carries a unique set of advantages and disadvantages to consider.
Looking to turn your hard work into an enduring financial legacy?
From transaction planning to legacy planning, download our full guide on Turning Your Wealth Into an Enduring Legacy to get started.
To turn hard work into an enduring financial legacy as a business owner, it is important that you begin talking with your wealth advisor about 18 months before selling your business or completing a dividend recapitalization. Assembling a coordinated team of advisors, including experts in wealth management, estate planning, tax planning, and investment banking, is essential to achieving a coordinated approach to planning for the liquidity event.
Time is your most valuable resource—the earlier you start wealth planning, the more opportunities you have. Conversely, if you wait until the transaction is about to close, you may miss the opportunity to capitalize on some of the most valuable strategies and pay more taxes than necessary. Following are important things to consider pre-transaction.
Establishing your vision
How Will a Business Sale Impact My Financial Future?
Making wise wealth decisions
Why Does My Wealth Advisor Need Time to Assess My Business Sale?
Transferring business value
Can I Benefit From a Valuation Discount When Transferring Business Shares?
Using scenario planning
Is There a Downside to a Valuation Discount When Passing on Business Shares?
What Else Can I Do to Build My Family Wealth?
How Do I Make the Most of Philanthropy?
How Will a Business Sale Impact My Financial Future?
Before you and your advisors can create a strategy for managing the wealth created from a sale, you need to identify your priorities and goals. This will include understanding how much capital is required to fund your lifestyle, as well as whether transferring wealth to loved ones or gifting money to charities are priorities.
A central part of this exercise is thinking about how you will balance your lifestyle needs versus secondary goals of wealth transfer and philanthropy. (Read more about quantifying the relationship between annual lifetime spending and excess funds.) Another important element is deciding whether you want to continue working after the transaction or whether you will count on your investment portfolio to generate a steady paycheck to support your lifestyle.
You do not want to feel rushed into making decisions that will likely have long-term consequences, and you do not want to be thinking about these things for the first time when you are in the midst of trying to sell or recapitalize your company.
Give yourself time to think through various scenarios and possibly engage family members in the process. Your wealth advisor will be able to guide you through this process and point out potential opportunities and pitfalls.
See Benefits of Personal Wealth Planning Before Selling Your Business.
Making wise wealth decisions
Why Does My Wealth Advisor Need Time to Assess My Business Sale?
You may want to get your personal wealth advisor involved about 18 months before your business sale to allow for time to assess the tax and cash flow timing consequences of potential transactions. This will also give your advisor time to create projections for how much after-tax wealth you will receive under a range of valuations and transaction structures.
Your advisors’ work to assess the deal structure is especially important for transactions that are not all-cash deals and involve equity compensation or earn-outs. You also want to give your wealth advisor adequate time to lay the groundwork for establishing any trusts, foundations, and other legal structures that will be used in executing your wealth-management strategy.
Whether the proceeds from a transaction are treated as long-term gains or ordinary income will have a significant effect on the overall tax exposure for the owners. The top federal long-term capital gain rate is 20% plus potential exposure to a 3.8% tax on investment income. In contrast, the top federal rate for ordinary income is currently 37%.
Wealth advisors can also help you understand elements of a purchase agreement that affect the ultimate value and timing of the liquidity, such as rollovers, vesting, and earn-outs.
One of the most powerful wealth-transfer strategies for owners of growing businesses is taking advantage of the pre-transaction “valuation discount,” an important consideration. The valuation discount is based on the premise that the value of the business before a transaction is often less than the value at which the company is sold.
When transferring shares of a company to children or other loved ones, the size of the gift for estate-tax purposes is based on the value of the shares at the time of the transfer. Any appreciation in the value of the shares that occurs after the transfer is not subject to estate or gift taxes. Thus, for companies that are growing, the earlier the shares are transferred, the more wealth the owner may be able to give to loved ones tax-free.
Timing is critical when it comes to taking advantage of a valuation discount. Often, when a company is sold through a merger or acquisition, or shares are sold through an equity recapitalization, the valuation used for the transaction is significantly higher than the pre-transaction valuation. If the owner wants to use the pre-transaction valuation for the gifts to loved ones, the transfer must have been completed before the owner signs the letter of intent for the business sale or recapitalization. After that letter has been signed, the valuation that is used for the transaction is likely the valuation that must be used for the gifts.
Using scenario planninG
Although the valuation discount can be a powerful way to minimize wealth-transfer taxes, it is important to remember that transferring wealth before the transaction closes carries risk. To take advantage of the tax benefits of the valuation discount, the transfers need to be irrevocable—you can not undo them if the valuation or timing of the transaction end up being significantly different than what you had planned.
Market conditions may deteriorate, causing the buyer to lower the company’s valuation significantly or perhaps walk away from the deal altogether. In these situations, business owners may end up with much less wealth or liquidity than what they were anticipating. Conversely, a highly competitive sale process may result in a valuation that is significantly higher than what the owners had predicted when deciding how many shares to give to loved ones before the transaction. William Blair advisors have seen situations where owners’ efforts to limit the wealth transfer to their children were undermined when the valuation of the company skyrocketed during a highly competitive sale process.
Using scenario planning to see what the outcomes may look like under various sale prices can be an extremely valuable part of the pre-transaction planning process. Creating a dynamic financial model that allows you to adjust variables such as purchase price, tax treatment, rollover equity amounts, and return assumptions will serve as a useful tool in estimating net proceeds and how much, if any, excess wealth is available for secondary planning objectives.
Ensuring future benefits
In addition to tax considerations and the valuation discount, there are other ways to strengthen a family wealth legacy.
Many business owners are committed to investing in their communities. When philanthropic business owners are ready to sell their companies, charitable giving may be a central part of their long-term wealth planning strategies.
Business owners considering a sale should discuss their long-term philanthropic goals with their wealth advisor. The proceeds from the sale can be used to fund charitable vehicles that generate a tax deduction for the donor, such as donor-advised funds, private foundations, charitable trusts, or outright gifts of stock.
There may also be an opportunity to establish charitable vehicles ahead of a business sale or transaction that can avoid or reduce exposure to capital gains tax. Accelerating the donations into the year of the sale can help offset the taxable income generated by the sale of the company.
By contributing low-basis stock instead of making cash gifts, business owners are able to avoid recognizing capital gains on this stock. It is important to note, though, that the gift of stock must be made before a letter of intent to sell the company has been signed; otherwise, the owner may violate the anticipatory assignment of income doctrine, and the full tax benefits of the gift may not be realized. There are many vehicles and methods that business owners can use to maximize the impact of their charitable gifts. Each approach carries a unique set of advantages and disadvantages.
How to Develop the Right Personal Wealth Strategy Before a Business Liquidity Event
Creating an enduring family financial legacy is about much more than the amount of wealth that is passed to younger generations. It also involves teaching children and their offspring to be good stewards of the wealth and teaching them about the values that have defined the family and the history of the company. Bestowing these lessons does not happen by accident. The most successful families take a proactive approach, which can be as formal as holding annual family meetings and forming a family foundation. They can be as informal as having regular conversations about the history of the company and explaining the family’s role in contributing to the community.
A grantor retained annuity trust (GRAT) is one of the most common vehicles used to transfer the future appreciation of the shares of a business to children without that appreciation being subject to estate or gift tax.
Determining the relationship between annual lifetime spending and remaining wealth is extremely valuable. Before you think about wealth-transfer or philanthropic opportunities, you must first determine your annual lifetime spending needs.
Quantifying your lifetime spending includes budgeting for annual recurring needs as well as any large purchases, such as vacation homes, boats, and travel.
Consider the example of a business owner who receives $40 million in after-tax proceeds from selling his business at age 55 and then invests the proceeds in a diversified portfolio.
If the client spends $500,000 annually, he is projected to have $78 million remaining upon reaching age 75. If the owner instead spent $750,000 annually on his lifestyle needs, his projected net worth at age 75 would be $69 million, and if the owner spent $1 million annually on his lifestyle needs, his projected net worth at age 75 would be $59 million.
A 55-year-old business owner’s projected net worth at age 75 based on $40 million in after-tax proceeds and various annual spending levels.
How Annual Lifetime Spending Affects Your Wealth
Net Worth at Age 75
The projections are based on the following assumptions:
85% probability of success
The annual spending rate is after taxes and adjusted for a 2% annual inflation rate
The investment portfolio is invested in 60% stocks and 40% bonds, and all proceeds are invested at the same mix
The portfolio’s projected returns are based on William Blair’s long-term investment expectations
Selling a business or generating liquidity through a dividend recapitalization offer business owners the opportunity to turn years of work into an enduring financial legacy. However, planning with a wealth advisor must begin far in advance of the business transaction to realize the greatest wealth benefits. The following is a case study showing how the right approach to wealth planning can result in substantial gains.
Client background: Maria and her husband, Thomas, founded a biotechnology company in 2004, and today their shares in the private company have a book value of $10 million. However, the company’s investment bankers project that if the company were acquired by a strategic buyer in a competitive process, the shares would be worth $100 million. Maria and Thomas, who have three children, have an additional $15 million in other assets and no debt.
Client priorities: Because Maria and Thomas have accumulated enough wealth outside of the company’s stock to support their lifetime spending needs, their primary goals are:
Illustrative Proceeds Maximization Case Study
Benefits of Personal Wealth Planning Before Selling Your Business
Passing wealth to their three children in a tax-efficient manner
Supporting several charities and giving their children an opportunity to be involved in deciding which charities to support
Minimizing income and estate taxes
Recommended strategy: To accomplish these goals, their wealth advisor recommends transferring 30% of the company stock ($3 million based on the stock’s pre-transaction book valuation) to trusts for the children and another 30% to a donor-advised fund (DAF) for charitable giving before the transaction closes.
By transferring the stock to the children’s trust, any subsequent appreciation in its value will be excluded from the couple’s taxable estate. By making the transfer to the DAF, they avoid paying capital gain tax on that portion of the stock. They will also receive a charitable income tax deduction, which will make the sale transaction more tax efficient. Maria and Thomas plan to fund their future charitable giving from the newly created DAF and incorporate the DAF into their estate plan.
Projected outcome: As depicted in the projection below, these effective pre-transaction planning strategies are projected to save Maria and Thomas $10.2 million in income taxes on the sale and $19.92 million in estate taxes.
Proper planning allows for substantial tax savings
Situation: Founder / shareholder to receive $100 million in proceeds from a transaction
Objective: Intends to donate roughly one third to charity over lifetime, one third to children
Sale of Company – $100mm Interest
Gross Estate (1)
Income Tax on Sale (2)
Estate Tax Exclusion (3)
Estate Tax (40%)
Income Tax on Sale (4)
Transfer Stock to Trusts (5)
Funding DAF Pre Transaction
Estate Tax Exclusion
Estate Tax (40%)
Maintain desired lifestyle while also accomplishing wealth transfer and charitable goals, tax efficiency
Realize Income and Estate Tax Savings
Fund trusts for three children
Wealth Transfer – Prior to Transaction
Fund charitable entity with company stock
Charitable Planning – Prior to Transaction
(1) Assumes shareholder has $10mm basis in company and value of $100mm at the time of the transaction. Also assumes that shareholder has $15million in other assets.
(2) Assumes 20% Long Term Gain Tax on $90 million plus Medicare Surtax at 3.8%.
(3) 2021 estate tax exclusion amount is $11,700,000 per individual.
(4) Assumes avoiding $27 million realized cap gain and obtaining a fair market value charitable deduction for 30% of company stock transferred to DAF pre transaction.
(5) Post transaction value off stock transferred to Children’s trusts through a grantor retained annuity trust ($3mm pre-transaction value).
$10.2 million in income tax savings
$19.92 million in estate tax savings
If you are a business owner interested in building a financial legacy, a grantor retained annuity trust (GRAT) may be very helpful.
What is a GRAT? It is one of the most common vehicles used to transfer the future appreciation of the shares of a business to children without that appreciation being subject to estate or gift tax. Here is how it works.
How a GRAT Transfers Business Growth to Future Generations
Trust makes fixed annuity payments to the grantor for the term of the trust.
Interested in learning more about GRATs?
Read our whitepaper on using a Grantor Retained Annuity Trust for Wealth Transfer Purposes.
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Grantor transfers shares of the company to the trust using the valuation at the time of the transfer minus any discounts.
Shares of business
At the end of the trust term, the amount remaining in the trust above the IRS published discount rate transfers to the beneficiaries tax-free.
Remainder value of trust
Grantor is responsible for paying income taxes and capital gains generated by the trust assets.
Source: William Blair. For illustrative purposes only.
Income taxes are paid by the grantor, which further shifts wealth to the beneficiaries.
At its simplest, charitable giving involves a donating a sum to an organization all at one time. This direct approach works well when a donor wants to make an impact immediately. However, it does not allow the donor to increase cash flow, diversify assets, or transfer wealth in a tax-efficient manner, which other giving strategies can.
There are many vehicles and strategies you can use to maximize the impact of your charitable donations. As outlined below, each approach carries a unique set of advantages and disadvantages, depending on your situation.
Comparing Charitable Giving Strategies
Simplicity and immediate benefit to the charity
Individuals who have identified a charity they want to support and want to make an immediate impact
Individuals who own low-basis, highly appreciated securities and would like to increase cash flow and diversify assets in a tax-efficient manner
Donor receives current or deferred cash flow and can diversify concentrated holdings without incurring immediate recognition of capital gains
Charitable Remainder Trust
Financially secure individuals who wish to transfer wealth to heirs in a tax-efficient manner and provide current cash flow to a charity
Charitable Lead Trust
Individuals who do not require income from donated assets and would like to avoid the cost and administration of a private foundation
Individuals who do not require income from donated assets and are interested in fostering family involvement with greater control
Creates an entity that can be named after the family; fosters continued family involvement and control
No involvement in grant-making decisions
Requires annual administration
Charity receives current cash flow; donor or designated heirs receive assets at trust termination; allows for significant tax deduction or tax-efficient wealth transfer
Requires annual administration; must be established as a grantor trust to qualify for income tax deduction
Easy to establish and maintain; ability to participate in distribution decisions; treated as a public charity for deductibility purposes
Requires donors to recommend IRS-qualified charities for grants, limiting control over management and administration
Requires annual administration; investment income may be subject to excise tax; deductibility limitations are more restrictive than with gifts to public charities
The sale of a business or a recapitalization can often elevate an entrepreneur to a dramatically higher level of wealth. This transition creates a new set of opportunities for you as a business owner, as well as some challenges that need to be addressed.
Completing a transaction involves a significant amount of planning and effort by you and your team of advisors. But what happens once a transaction has been closed and the proceeds have been received? Then, it is time to shift your attention to managing your wealth in a way that allows you to achieve your goals.
In addition to increasing your family’s net worth, a large liquidity event may also increase your family’s risk profile. After a transaction, you should conduct a comprehensive review of your insurance policies to ensure that the coverage, particularly in terms of liability, aligns with your new financial position. You should also review and enhance your personal security and cybersecurity protocols because a high-profile transaction may make your family more vulnerable to identity theft and other crimes. Conversely, certain insurance coverage, including life insurance policies, may no longer be needed due to the net proceeds from the transaction.
After a transaction closes, one of the biggest priorities you face is using the proceeds to create a diversified portfolio that generates a “paycheck” that will support your lifestyle needs and provide adequate growth. If you still have an equity stake in the company, your asset allocation should account for this concentrated equity exposure. If the transaction has an earn-out component, the range of potential cash flows generated by the earn-out needs to be forecasted and factored into the liquidity planning. Depending on the timing of a close, there may be an opportunity to generate some interest on the amount earmarked for taxes. Your planning also needs to account for any large one-time purchases you wish to make soon after the transaction.
When you reach the next level of wealth, you may have more opportunities to invest in institutional-level asset classes, such as private equity, venture capital, real estate, or investing directly in start-up businesses. Relative to traditional asset classes, these alternative investments are much less liquid and require a more rigorous level of due diligence and tax planning. Similarly, at larger asset levels, pre-packaged investment products, including mutual funds, may be less desirable relative to customized portfolios of securities, which offer improved tax efficiency and lower expenses.
The vast majority of business owners already have an established relationship with a financial advisor by the time a transaction occurs. In many cases, however, the wealth-management, risk-management, and tax-management considerations that come with a major liquidity event require a higher level of sophistication and the ability to take a comprehensive view of your total wealth profile. It may be beneficial to work with a wealth advisor who can coordinate the efforts of your tax, legal, and insurance advisors. It is also important to seek the counsel of an advisor who has experience working with business owners to help them navigate the many decisions that go into managing the wealth generated by a liquidity event.
Download our full guide on Turning Your Wealth Into an Enduring Legacy
Download our full guide on Turning Your Wealth Into an Enduring Legacy
Having guided many startup entrepreneurs and executives through liquidity events, both from investment banking and wealth management perspectives, William Blair can help you identify the most important questions to ask to determine if you are truly ready for a liquidity event. There are many different personal and financial considerations to keep in mind, and we are here to help you get started.
William Blair can help you work through personal and financial considerations, learn more in our full guide: Considerations for Every Entrepreneur.
Are you navigating your way through a liquidity event?
Liquidity: Financial Questions to Consider
If you are considering a liquidity event, it is time to ask yourself some important questions, from both a personal and financial perspective. At William Blair, we have worked with many startup executives and entrepreneurs. Through this experience, we have identified important considerations on both ends of the spectrum. Once you have answered the personal questions to consider before entering a liquidity event, it is time to ask yourself these financial questions.
Assuming you did not liquidate all your equity in the transaction, it is important to start thinking about how you can eventually maximize the value of your remaining equity and convert it to liquid wealth in the future. Completing another recapitalization or selling the company may certainly be an option.
While going public is the outcome that many entrepreneurs dream of, an IPO (initial public offering) is a reality for only a handful of companies. In most cases, it is difficult to generate liquidity from stock in private companies because the stock is not registered with the U.S. Securities and Exchanges Commission and the company imposes restrictions on reselling the stock.
As companies are staying private longer or delaying sales, companies are looking for ways to allow executives and other employees to cash in on the value of their equity. Pre-IPO companies are increasingly taking steps to facilitate mechanisms that allow employees to unlock liquidity from their stock through:
From a business perspective, the first consideration may be how to take your company’s growth to the next level. This could mean selling a minority interest to an institutional investor who has the right balance of capital and expertise to be a great partner. Alternatively, it may be finding the right strategic partner who may acquire the entire business. From a personal perspective, this can be one of the most challenging decisions executives—and founders in particular—face. Generating the liquidity necessary to achieve portfolio diversification and accomplish other wealth goals often means selling a portion of the company's equity. While this helps limit your risk, it also means giving up some opportunity to participate in the company’s future growth.
Balancing these factors is challenging but having a clear picture of your true risk exposure and the potential outcome under various scenarios makes this decision much simpler. In many cases, entrepreneurs will sell a portion of their equity, allowing themselves to benefit further down the road as the company continues to grow.
When planning for a liquidity event, one of the most important considerations is understanding the amount and timing of cash you will receive after taxes have been paid.
The earlier you and your advisors start doing this the better. You want to give your advisors enough time to assess the tax and cash flow consequences of potential transactions and create projections for how much after-tax wealth you will receive under a range of valuations for the business and transaction structures. This work is especially important for transactions that involve equity compensation, vesting schedules, or earn-outs rather than all cash.
You will need to identify how much of the proceeds will be treated as ordinary income versus long-term capital gains. A major part of this is understanding how the company is structured.
personal questions to consider before entering a liquidity event
Stock buy-back programs
Internal company stock exchanges
Opportunities for employees to sell shares directly to outside investors
Sales through private secondary exchanges
Often, when companies create opportunities to sell the stock, participation comes with additional restrictions on what can be done with the remaining stock.
Also, if you are rolling equity into the acquiring company, that equity presents an ideal asset to consider for longer term wealth transfer planning.
Qualified small business stock exemption
Pre-transaction valuation discount for wealth transfer
Offsetting gains with charitable gifts
While taxes should not be the main driver of your decision regarding how and when to achieve liquidity, they are a major factor in how much you can achieve with your wealth.
One of the main benefits of working with your wealth advisors early in the process to understand the potential tax consequences of a liquidity event is that it gives you more time and more options for implementing strategies to lessen the tax bill and maximize the amount of your wealth. You also want to give your wealth advisors adequate time to lay the groundwork for establishing any trusts, foundations, and other legal structures that will be used in executing your wealth-management strategy.
Some tools for managing the tax consequences of a liquidity event include:
Liquidity: Personal Questions to Consider
Achieving a new level of wealth opens new opportunities and subjects you to new levels of visibility and scrutiny. Many executives are surprised by how much active interest they receive once news of the liquidity event becomes public. Wealth will also bring heightened visibility and make you a bigger target, so make sure that you do a security and insurance assessment to protect you, your family, and your assets.
You will want to have your long-term plan and trusted team in place before these opportunities arise. This allows you to be proactive and intentional, rather than reactive, in how you assess these opportunities.
After the liquidity event occurs, your wealth goes from theoretical to tangible. In the case of selling a company, you transition from having a steady income to relying on your portfolio to generate a paycheck; this requires adopting a new mindset, managing your expectations about market fluctuations, and remaining focused on your long-term goals.
Now that you know what to think about from a personal perspective, find out what financial questions to consider.
Recapitalization through venture funding or private equity investment
Selling the business
Selling private shares on secondary markets
First, identify your short-term and long-term wealth goals and quantify what you will need to accomplish those. From there, you can differentiate between core and excess wealth, and think about new opportunities.
Often, high-net-worth individuals identify four high-level areas for the distribution of their wealth: taxes, core wealth (lifetime spending), a wealth transfer, and philanthropy. But for startup executives, there is often a fifth category: funding the next venture.
This next venture could be starting another company, becoming an angel or venture investor, or establishing a non-profit or foundation that looks to drive social change. Regardless of what that next chapter looks like, the more planning you do on the front end, the more opportunities you will have in the future.
Many executives at high-growth companies think about their wealth from a long-term perspective for the first time and have not yet established some of the basics of a solid financial plan. From budgeting for cash flows and estate planning to tax-advantaged retirement accounts and insurance and risk management, there is plenty to consider when it comes to personal wealth.
As you raise capital and generate liquidity, your financial life will get more complicated. You need to have a team of trusted advisors in place to help you navigate these complex decisions, including an accountant, estate planning attorney, investment banker, and insurance and wealth advisors. You also need to ensure you have someone to coordinate the team and make sure all the pieces are working together in unison. Often, a wealth advisor is in the best position to take on this role.
Each of these transactions raises its own set of questions. We believe the biggest question you face is: Are you ready? On the surface, this might seem simple. Of course, you are. You are ready to generate some cash and unlock the wealth you have worked so hard to build. But it can be more complicated than that.
Having guided many startup entrepreneurs and executives through these events, William Blair has identified the most important considerations to determine whether you are ready for a liquidity event. These questions generally fall into two categories: personal and financial. Here, we start with the personal questions to consider before entering a liquidity event.
There are many ways for entrepreneurs and executives to generate liquidity from the high-growth businesses they have built, such as:
Having realistic expectations about how much your equity is worth is critically important to making the most out of your opportunities. One of the biggest problems plaguing executives at private, high-growth companies is unrealistic expectations.
Some executives assume that the most optimistic projections of the company's growth will naturally come to fruition and result in sky-high valuations that will be easy for them to monetize. Others take the opposite approach and believe that projections about the company's growth and valuation are not of value.
Making good decisions requires an honest, realistic, accurate, and data-driven assessment; and understanding your personal risk tolerance and risk capacity is an important part of this assessment. This is where scenario planning can be helpful.
Selling a large portion of equity in a company that you have helped build can be difficult. Beyond the fear of giving up financial participation in the company's continued growth and some level of control in how the business is managed, entrepreneurs and executives often struggle with the prospect of losing something that has defined their identity and fueled their passion for years.
It is important to realize that these feelings are normal and understand that change is a natural part of life. When major life changes occur, it takes time to work through them; you do not need to have all the answers about what your next phase will look like right away. Stay focused on your long-term goals and give yourself time and space to work through the transition.
find out what financial questions to consider
Financial Planning Following a Liquidity Event
Download our full guide on Considerations for Every Entrepreneur
Here, we illustrate a transaction that results in $30 million in net after-tax proceeds. This founder had a lifestyle spending objective of approximately $600,000 after tax. Solving for an inflation-adjusted spending goal, we identified approximately $15 million that would be needed for a sustainable income stream. The excess proceeds could be set aside for two additional goals, funding wealth transfer trusts for children and allocating funds for future business ventures and direct investments.
Liquidity events can be transformative to your financial situation, as you shift from an opaque and illiquid balance sheet to one that is liquid, very transparent, and potentially volatile. Choosing the right wealth advisor to help you manage your personal wealth is the first step in taking a highly sophisticated and comprehensive view of your total wealth profile. Contact a William Blair advisor and start the conversation today.
Selling or recapitalizing your business may dramatically increase your level of wealth, which allows you new opportunities. When through a liquidity event, it is vital to consider your new financial reality. Whether you are retiring, shifting your focus to philanthropic endeavors, or investing in a new venture, you will want to have a long-term plan in place.
The financial modeling around your transaction aims to estimate the net after-tax proceeds you will receive from the transaction. As you approach a liquidity event, your wealth advisor will refine the terms of the transaction and more accurately estimate the net proceeds amount. This can then be used to address your primary planning objectives.
In many situations, your wealth advisor may consider financial independence as a primary goal, regardless of whether you will continue to work or earn income. You may want to understand how much capital would be needed to recreate a paycheck while factoring in the impact of inflation, income taxes, and market volatility. After understanding your current lifestyle spending requirements, your wealth advisor can solve for this “lifestyle capital” with a high degree of confidence. This process will then reveal if additional capital may be available for other planning objectives, including gifting to family members, earmarking funds for future business investments, and charitable giving.
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$30 Million Net Proceeds