When it makes sense to sell a stock for 80% of its value
Although still a popular provision in executive pay, company stock awards have become more common for many American workers, due in large part to the technology startup boom in the past decade.
This, of course, is happening as the U.S. public markets break records.
On August 22, news reports showed that the U.S. stock markets are officially experiencing the longest bull run in American history.
That makes this environment, among other things, an opportune one to cash out equity positions. In which case, employees of companies who want to realize the value of some or all that vested stock might want to consider a variable prepaid forward equity contract or so-called forward sale.
Granted, there are considerations to be made as this is a taxable event. Capital gains of 20% and income tax of about 35% will get clients when they try to bring their chips to the window, so to speak.
But it doesn’t have to shake out that way. That is what we are talking about here: how to best benefit from concentrated stock ownership without having to pay taxes on the sale of it today.
This strategy is common among executives who are in some ways flush with stock, which they have received often as a bonus. This issue hits close to home for us.
Here is an example:
We mostly work with individuals with investable assets of at least $15 million. We have a middle-aged client, a C-level executive, who was awarded as much as $4 million of company stock in a given year.
He is married and has children, for whom he has arranged a trust and expenses, in one case on real estate payments. Based on his financial needs, we actively employ this forward-sale strategy.
From a bird’s eye view, here is how it works:
Let’s say this client’s company stock is performing at an all-time high and analysts are positive on future company growth. He has $4 million of shares to sell.
In a forward sale, he could cash out these positions at about 80% of the share value, or $3.2 million today, under a contract that allows him to forgo paying taxes on it for about three years when the sale is complete. The transaction happens between him, the owner and usually an institutional buyer who can cover the shares (e.g., Merrill Lynch, Pershing, etc.).
Because the stock market performance for all intents is unpredictable, the owner could lose potential future gains in a forward sale like this. However, in many cases, and in this market environment in particular, it could be a risk worth taking. A client’s beneficiaries will thank you.
This story is part of a 30-30 series on tax-advantaged investing.