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Planning For Your Life’s First Liquidity Event

With proper planning, one can optimize tax liability, invest capital wisely to achieve defined goals, meet social and philanthropic goals and preserve the wealth to pass on to subsequent generations.

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It can be quite a challenging task to plan for your first liquidity event. Many business owners and professionals often find themselves underprepared to deal with a first-time liquidity event. Significant time and effort is spent in planning and executing the events that lead up to liquidity such as sale of business, sale of property, etc. but not in planning what to do with the liquidity when it comes in. 

As the liquidity event approaches, one needs to define and prioritize goals and take some important decisions:

1) How will the liquidity be used? Is it for self-use or is it an opportunity to transfer to subsequent generations?

2) How will the liquidity be invested? Is there are a strategy and plan in place that is consistent with long term investment objectives?

3) Will the liquidity be used to support social and charitable causes? Creating an estate plan: As it is rightly said “when water gets stored in a pond, it starts stinking after a point, as it is stagnant water. This does not, however, happen in a river. Water needs to flow for it to remain in proper, good condition. Wealth is like water. If it gets locked up, it becomes moribund and unproductive”.

Thus, it is a good time to step back and decide how assets will be managed during your lifetime and in what form, manner and shape will it be transferred to the next generation. Will they be transferred to an individual, trust, limited liability partnership or a corporate entity.

What is also important to the next generation, is not the wealth they inherit, but the family values and the legacy which the Patriarch of the family has established. A smooth succession plan is therefore necessary to preserve such values. Tax lawyers and estate planners can help draft out a structure that meets the needs of wealth distribution, optimizes tax liability ring-fences assets to protect them from unforeseen circumstances, as well as preserving the values of the family.

Defining an investment strategy: Once it is determined where the proceeds will go, an appropriate investment strategy needs to be defined. It is important to work with an investment advisor whose philosophy and approach is consistent with one’s thought process. Most traditional wealth advisors assess risk tolerance and create an investment plan to meet long term investment objectives using the asset allocation methodology. I prefer using the risk pool allocation methodology instead because it does not assign a single risk rating to an individual but believes that every individual has the capacity to take risk across a spectrum. It carves out three distinct pools of capital, after setting aside funds to meet known expenses, to address different risks in the portfolio – risk pool, market pool and aspiration pool. The strategy of the risk pool is to serve as a safety net and to help maintain and continue existing lifestyle, the strategy of the market pool capital is to provide market-linked returns and the strategy of the aspiration pool capital is to provide aggressive returns for enhancing life-style. Once the investment strategy is determined and implemented, it should be reviewed on an ongoing basis.

Creating a philanthropy plan: This is a good time to fructify plans to give back to the community. However, one should understand that the core practices and the nuances of philanthropic investments are often a departure from those used for market investments. A structured approach to Philanthropy is vital if you wish to maximize the impact of your donations. The first step in this form of ‘structured’ giving is to identify your philanthropic goals – which social causes do you wish to support, who are your target beneficiaries, which locations etc. Once your goals are in place, you will need to decide if you wish to set up a philanthropic vehicle (trust, society or a section 8 company), give directly to an NGO or fund through a combination of both. An experienced philanthropic advisory team can help you select and set up these structures as well as identify and evaluate partner organizations that will provide the expertise while providing outcomes on the ground. Committed philanthropic advisors can also assist in monitoring and evaluation (MnE)– an extensive but vital task. An ongoing MnE process will let you make changes to your strategy as well as ensure outcomes funded are indeed being achieved. Structured philanthropy is the surest way to optimizeyour tax liability while making a socio-environmental impact.

It is essential to plan well for a liquidity event so that one is not caught off-guard. With proper planning, one can optimize tax liability, invest capital wisely to achieve defined goals, meet social and philanthropic goals and preserve the wealth to pass on to subsequent generations. Having a strong and professional team of external partners and advisors such as tax advisor, lawyer, wealth advisor, philanthropy consultant, who can act as trusted navigators in liquidity event planning and execution, will facilitate the pre and post liquidity process.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.


Tags assigned to this article:
Liquidity Event tax planning investment

Ruchi Sankhe

The author is Managing Director, Origination and Client Coverage, Waterfield Advisors

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