Financial Planning

Generating Liquidity from Your Illiquid Assets

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If you own a family business, it probably comes as no surprise to hear that the average wealthy family holds more than half of its net worth in illiquid assets.1 In fact, according to a 2015 article in Forbes, “many business owners have 80% or more of their personal assets tied up in their businesses.”2

While it’s admirable to be so committed to your business, it’s exceedingly risky to maintain that much of your wealth tied to the fortunes of any single security — no matter how well run the company or how promising its future growth prospects — and those risks continue to intensify the closer you move towards retirement.

But it’s not just the risks associated with holding such a concentrated position that can be problematic; it’s also the extreme pressure it can place on your family’s cash flow situation. Through the strategic use of credit facilities such as lines and letters of credit, however, you can quickly and dramatically improve your cash flow, reduce or eliminate high-cost debt, better diversify your portfolio by exploring new investment opportunities, and potentially even minimize your tax burden.

Strategies to start monetizing your business

Many of you have probably reached a point in your career where you’re beginning to think about ways to monetize some of the considerable equity you’ve built up in your business. But you might not be ready to retire and by no means are willing to relinquish control. The following are just two of many ways you can start taking some chips off the table:

Dividend recapitalization — in sitting down with business owners, we often encounter single-owner firms with very little leverage where the owner has been exceedingly judicious in refraining from taking too much equity out of the company to fund future growth. As a result, while the business has flourished, their personal wealth picture has lagged behind. By using a term loan to extract equity (dividend recapitalization), the owner can gain considerable liquidity without creating excessive leverage or leaving the business cash poor assuming, the business’ annual cash flow is more than sufficient to pay back the loan.

For example, the owner of a business valued at $15 million with a $4 million annual cash flow could extract $10 million in equity with relative ease by taking out $5million in cash and securing a 7-year term loan for $5 million. The business’ cash flow will more than payback the loan, and in the interim he can put that $10 million in trust for his family.

Employee stock option plans (ESOPs) — ESOPs are specifically designed to facilitate the transfer of some or all of your ownership interest to your employees, over time, through a tax-qualified retirement plan that benefits all parties while preserving the sustainability of the business.

Utilizing a bank loan, the ESOP purchases 30% or more of the owner’s equity interest and places the stock in trust. Those shares are then allocated to employee accounts using a pre-determined formula, with shares vesting either immediately or over time, but only eligible to be redeemed upon retirement, death, disability or termination. The business then makes additional periodic contributions to the plan to cover principal and interest payments on the loan.

For the business owner, an ESOP offers a means to diversify a concentrated stock position and generate liquidity without relinquishing control. Depending on your corporate structure, the plan may also help minimize capital gains and provide federal income tax benefits. And it can prove a tool to motivate highly-valued employees while protecting the operational stability of your organization.

Needless to say, any withdrawal of equity from your business or liquidation of stock may have significant tax implications and therefore should only be undertaken in consultation with your tax attorney. But for owners and executives who wish to explore liquidity options, your SunTrust advisor can work with you to determine the most advantageous approach based on the structure of your business, your specific liquidity needs and your personal wealth picture.

For more on financial planning strategies:

Reach out to your SunTrust Private Wealth Management advisor or learn more here.

1 Financial Times, September 2016

2 Forbes, “Why Small Businesses Are Feeling an Economic Crunch,” October 2015

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