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- [00:02]
A
Welcome to the Path to Exit, a podcast to help software and Internet founders understand the process to raise capital or sell their business.
- [00:20]
B
Hello and welcome everyone. I'm Mike Lyon, Founder and Managing Director of VistaPoint Advisors and this is the Path to Exit. This show is dedicated to helping founders of software and Internet businesses understand what it takes to raise capital or sell their business and how to do it well. My guest today is Sarah Latono from Goldman Sachs. Sarah is a private wealth advisor who specializes in working with founders and entrepreneurs going through liquidity events. Sarah's been at Goldman for 17 years and worked with many of our former VPA clients. In today's podcast, we'll talk a little bit about tax planning, when to start planning, QSBs and estate taxes. Sarah, before we get started, can you tell us a little bit more about you and your practice?
- [00:55]
C
Sure. First off, thanks for having me Mike. As you shared, I'm a private wealth advisor at Goldman Sachs where I lead an eight person team. I've been advising clients in the financial markets for 17 plus years. My team and I specialize in working with founders and entrepreneurs going through liquidity events. We're very familiar with the process and the major planning considerations so the founders can maximize the amount they personally take home from a transaction.
- [01:18]
B
Awesome. Well, thanks for being with us and maybe to get us started, can you talk through maybe what the timeline looks like to start planning for a transaction process and really what are the biggest considerations a founder should be focused on?
- [01:30]
C
We recommend founders typically start planning around 18 months ahead of an event. It's easy to put planning in the back burner when you're focused on running the business and thinking about a sale. However, some tax efficient structures can take several months to set up and your window to realize a tax savings can close very quickly however. Hence why we want you starting that process early at that mark. What are the big items to consider? Number one, start thinking about putting together your team. The team is your bankers, your cpa, your financial advisor and your estate attorney. And number two, start thinking through tax planning.
- [02:05]
B
I think that's a really good point on the timing. My experience with this is oftentimes founders are really late to the game in putting their team together. But many times we're hired starting to work on a transaction and we realize they haven't thought through this timeline and not talking to anyone about the tax planning or tax and estate planning. So we definitely recommend that folks start early on that. There's some complications that really crop up. For example, if you already have an LOI and kind of establish the value of your business. It starts to either limit what you can do or just makes it much more difficult. You talked a lot about some of the considerations. Talk to us about the tax planning considerations that are relevant long before a transaction even starts.
- [02:45]
C
So first, while we don't provide tax advice, my team does help clients think through tax related considerations and close coordination with clients independent tax advisors. Second, obviously nothing I will be saying here will constitute investment advice and shouldn't be considered as such. It's critical any listeners obtain investment and tax related advice based on their particular circumstances when relevant. That said, at a high level, there's two tax regimes in the U.S. the income tax regime with which we're all familiar, and the estate tax planning regime. With regard to the income tax planning considerations, your attorney and or your accountant can work with your financial advisor to review your current business structure and propose alternatives for minimizing your income tax liability from a sale inclusive of the cap gains taxes. One option is realizing capital losses to help offset the capital gain from the sale if you are eligible for QSBS treatment. We're going to talk more about this in a moment. You will also want to make sure you're being mindful of that five year hold to ensure it's being met. Though first time founders are often less focused on charity at this juncture. Donations to a private foundation, donor advised fund, or directly to a public charity can first be used to offset income that would otherwise be taxed at ordinary income rates and can then offset capital gain income. Gifting highly appreciated stock can be very tax efficient since you can avoid the tax associated with any unrealized gain and generally benefit from a fair market value charitable deduction. Additionally, relocating to a state with lower income taxes and capital gains can also be beneficial under certain circumstances.
- [04:24]
B
I think those are really good points and several of our clients have taken advantage of locating to a lower income tax and capital gain state well before they considered a transaction. That's why I think it's really important to think about this several years before you're thinking about an exit. So some of those options are available to you. Sarah, you mentioned kind of the magic phrase there, qsbs. Our clients love to talk about QS and obviously some of the savings that it generates them. Can you just say a little bit more about what QSBS is?
- [04:52]
C
Yes, absolutely. Qualified Small Business Stock usps. It refers to the partial or the full exclusion of eligible capital gain upon the sale of certain C corps on gains of up to 10mil or 10x your basis. You need to meet a bunch of criteria in order to qualify, including 1 acquiring the original issue stock of a US C corp while the corp has less than 50 mil of gross assets, 2 the corp is deemed an active trade business which Most technology companies qualify 3 and 3 the stock needs to have been held for five years. Owners of QSPs may also rollover or defer the gains from the sale of QSPS if the stock was held for more than six months where the owner uses the proceeds to purchase other qualified small business stock within 60 days. Why does this all matter? Is potentially the significant tax savings.
- [05:45]
B
This is one of the largest tax savings that we see clients qualify for. Everyone's familiar with the gains of up to 10 million, but also the 10x your basis can create some interesting situations for businesses. So something to pay attention to. Obviously the complicating part here is who qualifies or who doesn't. So Sarah, could you just say a few words about what should founders do to ensure that they qualify or give them the best chance?
- [06:08]
C
If you're a C Corp, you should already have a great cpa. If you don't, we both VPA and Goldman can help you identify one and you should be working closely with that CPA to ensure everything is in place to qualify. We often do see founders who think they are in good shape. They believe they have QSPs, but they do not. In fact, it's a very nuanced piece of the tax code. Again, speak to your CPA to confirm you're set and keep a second eye on that five year holding period and know the exact date you're going to hit it.
- [06:37]
B
And I think on this point it's also good to get a second piece of advice. As Sarah said, I think we both work together and probably independently on deals where the founder thought they were really good with their QSBS status and then you get someone in there who's a little bit more sophisticated or frankly just specializes in this and you see problems. So I would definitely encourage you to get a second set of eyes on this, particularly if you're dealing with someone that they don't do this every day as part of their practice. And my advice on tax is usually good tax people really pay for themselves pretty significantly in a way that some other service providers don't. But I think paying a lot of attention to that and just making sure you have good advice. Get a section opinion where possible just to make sure you're really buttoned up there. So we talked a little bit about qsbs. Now, maybe it's not a topic everyone wants to think about, but estate taxes? There's also a lot to be done there in terms of some savings. Can you just tell me a little bit more about that and how founders should think about that?
- [07:30]
C
Sure, yeah. And just so you're all aware, estate taxes Refer to that 40% estate tax number Estate Gift and Generation Skipping Transfer taxes can also be impacted by the sale of the business. If you plan ahead, you can shift a portion of your anticipated future appreciation off your balance sheet by gifting business equity to your spouse, children or other beneficiaries through a dynasty trust. You might have heard of a slat, which is a spousal Lifetime access trust. It's a type of irrevocable dynasty trust that includes your spouse as a beneficiary. A SLAT can provide additional flexibility to an irrevocable plan by allowing your spouse to receive distributions of additional funds if needed. You might have also heard of a GRAP that stands for a grant or Retained Annuity Trust. Those allow you to contribute business assets to a trust and effectively freeze the value of your state ahead of the sale, thereby reducing your heir's future tax liability. These vehicles are both well used. They do not need to be complex, but they can be depending on your goals. Hence why we recommend you plan early. We talk about these structures with almost every founder. Recently this came up with the founder of a company looking to sell his business and working in concert with the investment banking team. The client transferred the ownership to a series of trusts for the benefit of the client's children and the spouse and that ended up saving about 10% of the transaction proceeds from going to tax taxes. Just a little bit of an example. On the other side of that, I had one instance where Jeff Koons from VistaPoint, managing director over at VistaPoint, he called me and this was actually the night before a holiday called me with the client in the line who was about to sign an LOI the next day. The founder had felt his planning was all buttoned up. Jeff knows a lot about these topics, dug deeper, realized the planning was not in fact all in order, called me that night and I quickly realized that we needed to do some strategizing, got our estate planning team on the phone that evening, we talked through some additional important planning considerations and ultimately the founder delayed signing the LOI a few days to get all the right vehicles in place that he worked with his tax advisors to structure and the story ended up having a good outcome. He was able to implement all the planning and sign the LOI in good order. But it would have been immensely less stressful if he had begun the planning months in advance.
- [09:48]
B
Yeah, great point and great story. And the thing I always like to remind founders of is when we talk about valuation, we almost always talked about valuation on a pre tax basis. Obviously. Obviously what you actually take home is on an after tax basis. So getting some of these things right can be really helpful to getting to a transaction that is optimal for you or the best transaction. And you see deals done sometimes with not the optimal tax structure where they're actually getting less in terms of take home proceeds than they could have gotten if they'd done this the right way. So we've talked a lot about timing and tried to let everyone know they need to plan ahead of time. What about closer to a transaction? What are the things that are focused on and they need to do closer to a transaction?
- [10:27]
C
Okay, so six to nine months in advance of a transaction, you want to have a great team in place, all taking an integrated approach. Your transaction team is going to identify potential problems and hash out solutions before it's too late. For example, a business owner transferring business assets to a grat while also contributing similar business assets to a donor advised fund would likely run into valuation issues that estate attorneys would need to resolve with the client's tax advisor. This level of coordination cannot and it does not happen on fragmented teams. In an ideal setting, each member of your support team is constantly asking each other questions. As a deal progresses and you're only a few months out, you want to have completed wealth transfer planning to heirs when appropriate and also ensure all the correct vehicles are in place to receive assets. You are going to be deep into the deal process and due diligence. And Mike, I know you see this all the time too. It's not an easy process. You want to have a team like mine help helping you with all those personal planning considerations.
- [11:27]
B
I think that's really important. The deal process is stressful enough and you'll be solely focused on trying to get to a close. Right. Once we have a deal we want to do, we're really focused on close. And some of this stuff can slide to the background if you don't have a team working on it. So having a specialist working on it I think gives you your best chance to do this right and get it done on time. So we talked about planning long before a transaction. We talked about planning just before the transaction and the transaction. What about after the close? What are the things after all the bankers and lawyers have left. What does the client need to focus on?
- [11:58]
C
My first suggestion for clients is to exhale knowing your team all work together to ensure the best possible outcome for the transaction. It's an amazing accomplishment to build and sell a business. We are so excited for our clients who achieve this incredible milestone. Second, I generally recommend clients hold off on big life decisions for at least six to 12 months after the transaction so that everyone in the family has time to adjust to a new reality. On the investing side, first, we want to ensure you're maximizing yield on your cash. Then my team and I work with you to design a customized tax efficient portfolio that takes into account your long term goals. We're going to typically build that portfolio out over several months to a year, depending on market conditions. We'll also help you think about your broader balance sheet, including liabilities. And we offer broader family office services as well, depending on a client's needs.
- [12:50]
B
I think this one's a really important point because oftentimes when we're talking to founders and they're trying to make the decision around am I going to do a transaction or not. I think they tend to underestimate the performance of their assets. So if they sell their business and reinvest those assets somewhere or just don't have a sense for it at all. So I think it's hard in a vacuum, particularly if you have a business that's producing a lot of EBITDA to understand would it be better off just growing the business and maintaining that EBITDA and not selling the business or selling the business and then reinvesting that capital. But I feel like some, sometime there's a disconnect there and then obviously once you sell the business, the money is more working for you than you working for the money. Obviously when you're managing a business there's a lot of stress and risk associated with that. But I feel like clients generally don't have an understanding of what that looks like afterwards. And someone like Sarah is helpful at understanding what your expectations might be. Post deals. Sarah, what about taxes after a transaction?
- [13:43]
C
I would just add there before we talk about that piece. It is a big transition to go from having the business pay you to having your portfolio pay you. So we do spend a lot of time helping you flesh out what that new reality looks like, what an appropriate budget can be and kind of what those expectations are, even pre deal so that you can get a feel for what life will be like after a transaction. On the tax piece. After a transaction, no doubt about it. Taxes are a client's biggest liabilities. We are maniacal about tax planning and investing in tax efficient portfolios. So we continue to stay closely coordinated with your CPA and your attorney and we'll refer you to new ones if you need them. We'll also look to invest the portion of proceeds earmarked for taxes in a low risk strategy. Typically that means T bills, money market funds, bank deposits are similar depending on what investment is offering the highest yield.
- [14:33]
B
Fantastic. Well, anything else you want to share and are you open to chatting with listeners if they have follow up questions?
- [14:39]
C
Yeah, of course. I'm delighted to chat. If you'd like to talk more about the specifics of your situation, you can call the VPA team for my contact info or call me at the Goldman Sachs office in San Francisco. And then just as a last note, I would just again encourage and remind listeners to start planning early. It really makes a big difference in terms of the ultimate outcome for you and your family.
- [15:00]
B
Well Sarah, thanks for joining us today. We talked a lot about planning so doing this upfront. We talked about qsbs, we talked about estate taxes. We also talked about not making any big life decisions for 12 months after a deal. So wait a while to buy that yacht and make sure you understand what your future looks like. But Sarah, thanks for joining us. Appreciate the time.
- [15:19]
C
Thank you.
- [15:21]
A
Disappoint Advisors is a founder focused investment bank that advises software and Internet founders through M and A and Capital Raised Transactions. We are a fully unconflicted investment bank who only works for founders on the sell side, so you know that we're always representing your best interests. Security is offered through VistaPoint Advisors member Finra Sipic. This has been provided for informational purposes only. It is not intended to address all circumstances that might arise. Testimonials from past clients may not be representative of the experience of other clients and there is no guarantee of future performance or success. Clients are not compensated for their comments. If you have any questions about the process of selling your business or raising capital, reach out to a member of our team or check out the four Founders section of our site by visiting four Founders Guide.