With more than 40 firms having gone public since the year began, 2014 is shaping up to be a hot year for initial public offerings.
In addition to public offerings, a brisk amount of M&A activity in the technology sector, including the $19 billion Facebook acquisition of WhatsApp, has created a brand-new class of stock-wealthy executives. For wealth managers, meeting the needs of the Class of ’14 is a complex task that requires careful planning and advice for risk management.
Any recipient of newly minted equity can be overwhelmed, never mind that of a windfall on the scale of some produced by a tech IPO. Demetri Detsaridis knows this firsthand. He was a senior executive at New York social-gaming company Area/Code in 2011 when it was acquired by Zynga in the lead-up to the IPO of the San Francisco–headquartered gaming company (FarmVille and Words with Friends). Detsaridis has seen early-stage employees grappling with a long list of problems associated with newfound paper wealth, though he was fortunate himself to have a financial adviser guide him through his investment options, especially with regards to tax efficiency. “The equity and equity-options programs are set up in such a way that often the easiest way to sell is the worst and least tax efficient,” he says. “That’s because the procedures implemented are the most frictionless for the company itself and the institutional service providers, as opposed to benefiting individual employee shareholders.”
Registered investment advisers suggest engaging in estate planning as early as possible, especially for founders and early-stage employees with dependents. “When the asset value is most likely at the lowest that it will ever be — that’s probably where you get the most bang for your buck when you do estate planning,” says Richard Bloom, a CPA, personal financial and tax adviser at WeiserMazars working at the firm’s private client services and tax practices group in Edison, New Jersey. “Setting up a trust when you set up the business and putting company stock or the limited-liability company interest into a child’s name at the inception to ensure that any future growth is out of the estate are strategies they should be considering.”
CTC Consulting/Harris myCFO, a wealth management division of Chicago-based BMO Harris Bank, which is owned by Bank of Montreal, has $34.5 billion in assets under management. Much of its clientele is part of the Silicon Valley tech elite.
James Cody, director of estate and trust services at CTC Consulting/Harris myCFO in Palo Alto, California, agrees that it is best to do financial planning before a liquidity event like an IPO or a sale, if possible. “We’ve discussed creating grantor retained annuity trusts, or GRATs, with young technology executives, and they look at us like we are crazy,” he says. According to Cody, single, childless, young tech millionaires often ask why they would need GRATs, an investment vehicle that pays out an annuity for a set period of time, after which any remaining funds are passed tax free to a beneficiary, often a close family member. Cody points out that benefits from GRATs have multiple uses. Recently his firm has constructed plans for the non-U.S.-citizen significant others of clients as a strategy to minimize gift tax treatment for foreign recipients, which can be prohibitively costly.
Sometimes the ability to cash in on paper wealth isn’t dependent on a merger or an IPO. “Of the companies set to go public this year, there will be a good-size percentage that executed a program with us,” says Bill Siegel, vice president of platform operations at New York–headquartered SecondMarket, a website for trading illiquid assets.
Founded in 2004, SecondMarket rose to prominence during the past few years as an intermediary of private stock transactions with companies like Facebook, Twitter and LinkedIn, prior to their respective public offerings. A major focus of the firm is allowing secondary transactions for companies that do not intend to go public in the near term but wish to provide liquidity for employees by allowing them to sell shares into tender offers by the company itself or primary initial investors. Working with the issuing company’s counsel, SecondMarket allows current and former employees and early-stage investors to sell vested shares into the offering — within certain parameters. “During the years before the Facebook IPO, there was a swarm of brokers looking for liquidity anywhere they could,” Siegel notes. “It was a disruptive process for the companies and the employees.”
Siegel, who is responsible for overseeing all private company transactions at SecondMarket, says that many of SecondMarket’s clients use annual and semiannual tenders not only to unlock value in illiquid shares but also as a human resources–related function to retain and reward employees.
Regardless of how and when the liquidity event occurs, human nature leads investors into predictable traps. Cody has managed a number of situations in which young technology clients, flush with success, dive into a series of investments in brand-new — and often risky — start-ups headed by friends and colleagues. “We counsel them to manage their wealth responsibly and to remember that they may never achieve such a dramatic payday again,” he says.
