Preparing For An M&A Exit: Managing Finances For Founders
But one area entrepreneurs often overlook is their personal finances and how those finances are affected by decisions that the company makes. This can particularly be the case if their startup is acquired, but it can also apply even if a company is not acquired.
Many founders neglect to deal with these matters because they are so busy building their companies. But often, they will realize their mistakes and if they start a second company, they will make the time for it, says Elliott Elbaz, founder of Mill Valley, Calif.-based Gordian Wealth Advisors.
For founders who are close to or above $10 million in net worth (if married) or $5 million (if single), planning can make a big difference in tax implications and estate planning.
Clearly, everyone’s situation is unique (and this post should not be considered financial advice), so entrepreneurs should talk to an investment professional or advisor about their specific situation. That being said, here is a brief overview of some important tips for entrepreneurs:
– Qualified Small Business: When starting a company, the type of incorporation is important and should be carefully considered. If you set up a C corporation, you can sign up for a Qualified Small Business Election – if you acquired the stock after Sept 27, 2010. This tax incentive gives a tax benefit if you hold stock in a company for five years before the company is worth up to $50 million. While there is no way to know what will happen in five years, it’s worth it to prepare for this, says Michael Phippen, chief investment officer at Gordian Wealth Advisors.
– “Key man” Insurance: A “key man” is a critical person to a company who can trigger certain structural changes in a company. (Key man clauses, which are often part of venture capital firms, can enable a VC firm to disband if certain partners are incapacitated or die.) Key man insurance can be triggered in the event of a person dying, being incapacitated or in some instances leaving the company. Once triggered, the key man insurance is paid to the company, which would then buy back the company’s shares from the key man. The shares could then be used to bring in a new person. For small startups key man insurance may not be used, but often for larger companies, key man insurance is used and some VCs will insist on it.
– 83b Election: This early exercise of company stock, which can be instituted for founders or employees, enables founders or early employees to exercise stock options and purchase stock early – before the stock has vested. This can enable the shareholder to save significantly on taxes in the event of a liquidity event by paying long-term capital gains instead of short-term gains.
– Estate Planning: If you’re married with children, there are a number of things you can do to maximize what you give to your children or other beneficiaries. One thing to know: you can give a “lifetime gift exception” of about $10 million (for married couples) to your children and not have it count towards your estate – i.e. not be taxed. Anything above that will be taxed. But with estate planning, you can ensure that you give to your children and minimize tax implications.
One thing you can do is set up a Grantor Retained Annuity Trust or GRAT. In this scenario, a trust is created for a certain period of time. You would pay tax upon establishing the trust. When the trust expires, the beneficiary – your children or a charity – could receive the assets tax-free. If the assets are shares in a company, for example, this can be particularly beneficial because there are a number of things you can do with shares including borrowing against them.
– Why is this planning so important? You could be paying much more in tax if you don’t plan. Also, if you have children and you want to pass some of your wealth on to them, the amount you give to them could be greatly affected by tax implications, Elbaz says. “You could pay a big tax bill,” Elbaz says. “Also, if you take some of that wealth that will be created out of your estate, it’s less taxable upon your death if you do it smartly.”
“That’s why advisors can help. Because most entrepreneurs are so busy running and gunning and growing their business they often don’t focus on this,” he says. “We try to help entrepreneurs early so it doesn’t cost them. Otherwise, they’ll say, ‘I wish I would’ve known.’”
It’s a lesson that many entrepreneurs learn the hard way. “Typically entrepreneurs who are pretty successful have multiple exits and they get smarter over time. The first time they get enlightened, so the second time they know that they should set these things up. The third time they know it. It’s old hat.”
Preparing for an Acquisition:
– How to Prepare for M&A: If you know your company could be acquired, there are certain things you can do personally to prepare for this event that could make a big difference financially. You can gift some of your shares through a GRAT, as mentioned above, or a family limited partnership. In the event that your shares are acquired by a large company, having those shares in a GRAT or other form of trust could minimize the tax implications for you, the founder, as well as for your children, spouse or charity.
– Many Permutations: Of course, this depends on what kind of acquisition it is. If you’re being acquired for stock, you have more options to lessen tax implications. For example, for founders who have a large amount of stock in one company after an acquisition, there are exchange or swap funds for investors to pool large single stock positions in exchange for shares in the fund. This diversifies your holdings without having to directly sell the shares, Elbaz says.
Here are more tips from Gordian Wealth Advisors in this infographic: