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Unlocking the value of your biggest asset, your business

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Presented at XPX Summit 2009 at Babson College, Wellesley, MA

Presented at XPX Summit 2009 at Babson College, Wellesley, MA


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  • Note: This example creates a $432,202 transferable gift. Most likely this will not create an out-of-pocket expense, as you each currently get $1.0 million of estate/gift tax exemption from the Federal government. Note: The annual payment can come from liquid assets you put in the GRAT, when you initially form the GRAT, or it might come from dividend distributions related to the privately held stock
  • Notes: Balloon payment due at the end of year 9 – no pre-payment penalty Liquidity to make the balloon payment will come from future sale of business Parent/owner can make annual gifts to note purchaser to help him/her afford the annual interest amount due No gift tax All future appreciation on privately held company stock moved downstream
  • The presentation that this example came from then went on to say that, Cuban acquired, with his good fortune, the following assets/toys: A $41 million Gulf-Stream V, A 24,000 sq. foot bachelor pad where he holds wiffle ball tournaments in the chandelier ballroom, and He became the owner of the NBA Dallas Mavericks.
  • Transcript

    • 1. Unlocking the value of your biggest asset… your business Robert Katz, CFP, Principal Todd Speed, CFA, Portfolio Manager
    • 2. What are the goals of someone holding a large block of a single low cost basis stock?
      • Transfer a portion of the value to one’s beneficiaries
      • Increase liquidity
      • Create portfolio diversification
      • Develop periodic income for one’s family
      • Protect against unexpected declines
      • Maintain some portion of ownership in the stock
    • 3. The goals noted are often complicated by
      • Ever changing estate law and income tax rules
      • The availability and trading volume of listed options in your stock
      • Your affiliation with the issuer of the stock you are holding
      • Navigating the legal transfer process
    • 4. Privately held stock – strategies to consider
      • Grantor Retained Annuity Trust (GRAT)
      • Sale to a family member – take back a note
      • Both of these strategies can:
      • Provide you with a second paycheck
      • Remove future appreciation from your estate
      • Move assets to the next generation, estate tax free
    • 5. Privately held stock – strategies to consider
      • 1) Grantor Retained Annuity Trust (GRAT)
      • What is a GRAT:
      • A GRAT is an irrevocable trust into which an individual, a Grantor, places stock or other assets into a trust for a fixed period of time while retaining the right to receive the principal and interest rate back in the form of annuity payments, “A Second Paycheck.”
      • What assets are best to put into a GRAT?:
      • Shares of a business before it is sold or goes public
      • Real Estate that can be appraised today at a low value
      • Highly appreciated, publicly traded stock
      • Private partnership shares
    • 6. Privately held stock – strategies to consider
      • 1) Grantor Retained Annuity Trust (GRAT)
      • Advantages:
      • Assets Placed in the GRAT may be discounted for gift tax purposes
      • You can consider a “zero-out” GRAT which may escape all Federal gift tax liability
      • All future privately held stock appreciation will escape estate tax liability that might occur if left in your name at your passing
      • The Grantor will pay the income tax due on the taxable transactions within the GRAT, an additional gift with no gift tax
      • The Grantor is creating “A Second Paycheck”
      • Disadvantages:
      • Fees to set up the GRAT
      • This is an irrevocable gift
      • Remove the ability to get a step up in basis at Grantor’s passing
    • 7. Privately held stock – strategies to consider
      • GRAT Example
      • Using historically low IRS 7520 rate of 2.40% for March, 2009
      $1,875,373.85 $300,000.00 $0.00 $1,175,373.85 $1,000,000.00 Summary $1,875,373.85 $50,000.00 $0.00 $251,135.72 $1,674,238.13 6 $1,674,238.13 $50,000.00 $0.00 $224,900.63 $1,499,337.50 5 $1,499,337.50 $50,000.00 $0.00 $202,087.50 $1,347,250.00 4 $1,347,250.00 $50,000.00 $0.00 $182,250.00 $1,215,000.00 3 $1,215,000.00 $50,000.00 $0.00 $165,000.00 $1,100,000.00 2 $1,100,000.00 $50,000.00 $0.00 $150,000.00 $1,000.000.00 1 Remainder Annual Payment 0.00% Annual Income 15.00% Growth Beginning Principal Year
    • 8. Privately held stock – strategies to consider
      • 2) Sale to a family member – take back a note
      • Example:
      $500,000 $9,700 $9,700 1.94% $500,000 Year 9 $500,000 $9,700 $9,700 1.94% $500,000 Year 8 $500,000 $9,700 $9,700 1.94% $500,000 Year 7 $500,000 $9,700 $9,700 1.94% $500,000 Year 6 $500,000 $9,700 $9,700 1.94% $500,000 Year 5 $500,000 $9,700 $9,700 1.94% $500,000 Year 4 $500,000 $9,700 $9,700 1.94% $500,000 Year 3 $500,000 $9,700 $9,700 1.94% $500,000 Year 2 $500,000 $9,700 $9,700 1.94% $500,000 Year 1 Note Balance Interest Paid Interest Due Mid-term AFR Note Balance
    • 9. Publicly held stock – strategies to consider
      • Cuban held approximately 14.6 million shares of Yahoo, which were trading at $95 per share, for a total market value of nearly $1.4 billion.
      • Cuban had several strategies to consider, some of those were:
        • Sell his shares and recognize his gains
        • Hold the shares in hopes of future gains but at the risk of a future loss (“let it ride”)
        • Engage in a collar or other hedging transaction to lock-in certain gains
      Mark Cuban Yahoo Stock Dotcom era example
    • 10. Publicly held stock – strategies to consider
      • Cuban elected to:
      • Enter into a 3-year “costless” collar for his Yahoo stock.
      • It is estimated that Cuban received a floor of $85 a share and a cap of $205 per share.
      • Initially, when Yahoo soared to $237 per share in January of 2000, Cuban’s collar did not appear to be a wise move, but in light of Yahoo’s subsequent fall in price to roughly $13 a share, the collar may have saved Cuban over $1 billion dollars.
    • 11. Publicly held stock – strategies to consider
      • Lenk, on paper, made the Forbes list of the 100 wealthiest technology executives.
      • But, Mr. Lenk believed in his company so much he hardly cashed in any stock. His optimism cost him $600 million in paper wealth as his online retail company descended into bankruptcy a little more than a year after its market peak.
      • Lenk, did nothing to protect the downside and his eToys stock value plummeted to about $500,000.
      • Last known to be the President of Gap Inc. Direct, the company’s online division… and most of you have never heard of him.
      How many of you have heard of Toby Lenk, the eToys CEO who did the opposite of Mark Cuban? eToys.com
    • 12. Publicly held stock – strategies to consider
      • Create a Charitable Remainder Uni-Trust (CRUT)
      • Borrow Against the Stock Position
      • “ Exchange Fund” for Diversification
      • Outright Sale of Company Stock
      • Strategies that consider the use of options:
      • Protective Put Strategy
      • Covered Call Writing Strategy
      • Zero Cost Collar Strategy
      • Prepaid Variable Delivery Forward Strategy
    • 13. Publicly held stock – strategies to consider
      • 1) Create a Charitable Remainder Uni-Trust (CRUT)
      • Advantages:
      • Avoids capital gains tax once the stock is sold by the CRUT,
      • Once sold you have created portfolio diversification,
      • Creates a periodic stream of income, a second paycheck, for a chosen beneficiary,
      • Ultimate beneficiary is a charity or family foundation of your choosing,
      • Immediate income tax deduction at time of gift.
      • Disadvantages:
      • The single largest disadvantage is that you have given away assets irrevocably.
      • Consider an ILIT
    • 14. Publicly held stock – strategies to consider
      • 2) Borrow Against the Stock Position
      • Advantages:
      • Borrow up to 50% of the unrestricted value of the stock,
      • The liquidity created from borrowing will allow you to create portfolio diversification,
      • No capital gains tax (you borrowed, you did not sell) to be paid.
      • Disadvantage:
      • You have created margin investment expense.
    • 15. Publicly held stock – strategies to consider
      • 3) “Exchange Fund” for Diversification
      • This type of fund, albeit sometimes hard to find, offers diversification with no initial capital gains tax due upon admittance into the fund.
      • The fund manager coordinates together individuals that have large concentrations in a single stock.
      • Participant selection is done by the fund manager whose goal is to create a diversified portfolio, comprised of many industries with various size capitalization holdings.
      • Accordingly to avoid capital gains taxes, these funds typically limit redemption’s in the first 5-7 years of the fund. It is important that you and your investment advisor carefully review the exchange fund holdings to ensure the quality of the portfolio is consistent with the client risk-reward profile.
    • 16. Publicly held stock – strategies to consider
      • 4) Outright Sale of Company Stock
      • Assuming you are the CEO board member, founding shareholder, etc., you may be subject to company open trading windows or blackout periods.
      • As such you may want to consider an automated 10b5-1 Trading Plan.
          • This will protect you against insider sale claims.
          • Should be established during an open window.
      • Advantages:
      • Liquidity
      • Diversification
      • Disadvantage:
      • Tax Liability
    • 17. Strategies that consider the use of options
      • 5) Protective Put Strategy
      • Enables the investor to hedge a concentrated equity position,
      • Places a known maximum limit on stock price risk (creating downside protection),
      • Pre-determined cost to the investor upfront,
      • The investor retains upside appreciation in the stock, as well as voting rights and dividends,
      • This strategy is useful for maintaining stock exposure.
    • 18. Strategies that consider the use of options Profit/Loss Per Share 20 15 10 5 0 -5 -10 -15 -20 -25 85 90 95 100 105 110 115 Stock & Put Stock Stock Value at Expiration Put Purchased Against Stock
    • 19. Strategies that consider the use of options
      • 5) Protective Put Strategy
      • Advantages of this strategy:
      • Reduce risk – minimize or eliminate risk of holding a concentrated equity position below the Put strike price.
      • Upside Participation – maintain full participation in the appreciation of the underlying stock, less the premium paid.
      • Customized Structure – You participate in customizing the variables (i.e. floor /strike price and maturity).
      • Retain Stock Ownership – Investor receives dividends and may retain voting rights.
      • Possible disadvantages:
      • Cost – Investor pays an upfront premium, resulting in an initial cash outlay.
      • Liquidity – Certain contracts are not actively traded and may be difficult to unwind.
      • Diversification – Your portfolio remains concentrated.
      • Tax and legal – We always suggest you consult with your tax and legal team of advisors. We would be happy to participate.
    • 20. Strategies that consider the use of options
      • 6) Covered Call Writing Strategy
      • Investor receives an upfront premium/ cash flow for agreeing to sell the stock at the call strike price at maturity.
      • Enables an investor to partially hedge a concentrated holding.
      • Investor retains ownership, voting rights and dividends.
    • 21. Strategies that consider the use of options Profit/Loss Per Share 25 20 15 10 5 0 -5 -10 -15 -20 95 100 105 110 115 120 125 Covered Calls Stocks Stock Value at Expiration Covered Call
    • 22. Strategies that consider the use of options
      • 6) Covered Call Writing Strategy
      • Advantages of this strategy:
      • Yield /Cash flow enhancement – Investor receives upfront premium while maintaining a long stock position.
      • Downside Hedge – Investor offsets potential stock downside by the amount of premium income received.
      • Customized Structure –You participate in customizing the variables.
      • Retain stock ownership – Investor receives dividends and may retain voting rights.
      • Possible Disadvantages:
      • Limited Upside – Your upside is capped at the call option strike price.
      • Downside Exposure – Investor is left unprotected from depreciation in the stock price, below the premium received.
      • Diversification – Your portfolio remains concentrated.
      • Collateral – Full collateral must be posted to the broker.
      • Tax and legal – We always suggest you consult with your tax and legal team of advisors. We would be happy to participate.
    • 23. Strategies that consider the use of options
      • 7) Zero Cost Collar Strategy
      • No upfront premium will be paid by you the investor.
      • 2. The investor creates downside protection below the Put strike (floor) and gives up appreciation potential above the call strike (ceiling), effectively creating what is known as a “collar” around the stock.
      • 3. Both the floor and ceiling can be set at almost any point, but are generally priced so that the transaction is costless to you the investor.
      • 4. This strategy is useful to protect the value of the stock you received but may have temporary selling restrictions in place and you do not want to pay a premium for that protection.
    • 24. Strategies that consider the use of options Zero Cost Collar Downsize protection below Put Strike Price Forgone upside above Call Strike Price Portfolio Value Stock Price
    • 25. Strategies that consider the use of options
      • 7) Zero Cost Collar Strategy
      • Advantages of this strategy:
      • Reduce Risk – Investor eliminates downside risk in the stock, below the Put strike price and participates in the stock price appreciation up to the call strike.
      • Customized Structure –You participate in customizing the variables.
      • Retain stock ownership – Investor receives dividends and may retain voting rights.
      • Ability to Monetize – Investor can monetize the transaction with financing provided by the broker.
      • Possible Disadvantages:
      • Limited Upside – Investor’s upside is capped at the Call option strike price.
      • Downside Exposure – Investor is left unprotected from depreciation in the stock price down to the Put strike.
      • Tax and legal – We always suggest you consult with your tax and legal team of advisors. We would be happy to participate.
      • Diversification – Your portfolio remains concentrated.
      • Collateral – Full collateral must be posted to the broker.
    • 26. Strategies that consider the use of options
      • 8) Prepaid Variable Delivery Forward Strategy
      • Enables the investor to reduce downside/concentration risk in the stock.
      • The investor will receive upfront liquidity with no restrictions in order to help the investor diversify.
      • The investor is willing to relinquish appreciation of the stock above the cap price and would like to maintain ownership, voting rights and current dividends.
    • 27. Summary of Publicly Held Strategies * Investors should consult their own tax and legal advisors regarding structures NO NO YES (Payable to Investor) YES (Payable to Broker) NO Premium YES YES YES YES NO Deferral of Tax Event* YES (with Reinvestment) NO (Yes with Broker Financing and Reinvestment) NO NO (Yes with Financing and Reinvestment) YES (with reinvestment) Diversification YES (Imbedded in structure) YES (with Broker Financing) YES (Capped) YES (with Broker Financing) YES Liquidity YES (Capped) YES (Capped) YES (Capped) YES (Unlimited) NO Upside Potential YES YES NO YES YES Downside Protection Prepaid Variable Delivery Forward Zero Cost Collar Covered Call Protective Put Outright Sale Goal