Top Five Wealth Planning Questions for Entrepreneurs

Keep these in mind when preparing for your future

Back Q&A Jun 21, 2016 By Dan Schrauth

Entrepreneurs tend to be forward-looking: They aim to develop cutting-edge technologies and drive industry-changing innovation with an eye toward shaping the future. Having a long-term outlook should be applauded — and that view should extend to personal finance topics, as well.

Planning for the future is no less complex than navigating the growth of your business, and questions such as, “When should I exercise my options?” and “Do I need life insurance?” deserve the same critical consideration as your company’s operating budget. For entrepreneurs, in addition to cultivating a financially healthy business, it’s important to have a clear and focused plan for managing personal wealth. Developing answers to these five key questions can help you plan accordingly:

1. Are my shares eligible for Qualified Small Business Stock treatment?

Proceeds from selling QSBS held for five years prior to sale may be subject to a reduced federal capital gains tax rate — as low as zero percent — on the first $10 million of gain (or 10 times basis in the stock if that amount is greater than $10 million). QSBS is defined as stock acquired at original issuance from a C-corporation that meets the definition of a “qualified small business.” Among other criteria, a qualified small business cannot have gross assets in excess of $50 million at the time the stock is issued. For many technology-focused startups, a founder’s common stock, early rounds of preferred stock issued to investors and common stock purchased through option exercise may qualify as QSBS.

2. When should I exercise my options?

Many entrepreneurs exercise options — in particular, Incentive Stock Options — well before their expiration date.

When there is no “spread,” or minimal “spread” between the strike price and the fair market value/409A value of common stock, the primary reason for early exercise is to start the long-term capital gains clock running on all future share appreciation.

Early exercise may also make the purchased stock eligible for Qualified Small Business Stock tax treatment. As mentioned above, QSBS can reduce the federal capital gains tax rate to as low as zero percent on the first $10 million of gain — though specific criteria must be met in order to qualify.

Before taking any action, work with your financial team and accountant to carefully consider the income tax consequences and assess your available liquidity — or access to liquidity — to pay for the stock at the strike price, as well as to cover any tax liabilities that may be triggered by the exercise.

3. What if I am planning to buy a home?

Many first-time entrepreneurs will use funds from the sale of private company shares in a secondary transaction to buy a home. It may make sense — if feasible — to purchase the home with cash, and then to take out a mortgage after buying the property.

Interest paid on the first $1.1 million of mortgage indebtedness can serve as a valuable income tax deduction to offset income. Given low current rates, you may consider taking out additional mortgage debt above the $1.1 million threshold and investing the proceeds; if properly structured, interest paid on mortgage debt above $1.1 million is deductible against investment income.

Another consideration when considering a property purchase is privacy. Maintaining privacy is a major area of concern for many entrepreneurs. As such, buying and financing a home in the name of an LLC or trust, if properly drafted and administered, can prevent disclosure of the entrepreneur’s name in the public record.

Please carefully consult your financial team to develop a plan that is best suited to your individual needs.

4. Should I be thinking ahead to future charitable giving?

Most entrepreneurs with significant philanthropic objectives will make gifts to charities after an initial public offering or sale of the company. (In some cases, the entrepreneur may make a gift of pre-deal private company stock to a charity.) Timing for these donations is important, and it may be wise to help offset a large income year — for example, the year of a company’s sale — with a corresponding charitable donation.

Unlike gifts to family members, where the goal is to give property when the value is still low, gifts to charity are usually made with highly appreciated assets such as post-IPO stock. This is because the charitable income tax deduction is generally based on the fair market value of the gift.

For many entrepreneurs, it may make sense to establish a donor-advised fund or private foundation as a vehicle for their charitable giving.

5. Do I need life insurance?

When exploring how to meet the challenges and complications that may arise from the unexpected demise of an entrepreneur, term life insurance can be a useful option. Term life insurance can be a temporary and inexpensive way to protect against the adverse tax and liquidity effects if an entrepreneur passes prior to a company’s IPO or sale. The proceeds of life insurance can be an available source of cash for your estate or your family for the purposes of exercising your stock options, or to pay estate tax on illiquid private company shares included in your taxable estate.

When focused on the daily workings of running a business, it can be difficult to carve out time to tackle yet another set of financial decisions. But taking the time to address these topics can give you clarity, security and better insight into your options and opportunities.

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