How to Plan for a Liquidity Event

By Anna E. Diaz, Hope Carlson on October 14, 2020

Are you getting ready to sell your business?  Perhaps you’re about to have an IPO.  Either way, you may be facing a significant liquidity event that will transform your financial life.  Your work is likely hectic, filled with not only operating your business as usual, but also preparing for the event.

There are also planning considerations for you personally.  A liquidity event can be life changing.  The impact on you and your family can be significant, but you’ll need to be proactive to ensure you preserve the opportunities your wealth provides.

Here are three main things to consider when you are facing a possible liquidity event:

1. Financial Planning

While many think of financial planning as lining up income, expenses, savings, and goals to plan for retirement, in the context of a liquidity event, it’s more about planning for the scenarios before and after the business sale.  You may be wondering how cash flow will work until the sale and then afterward.  Perhaps you’re evaluating how much of a payout you need to negotiate before you’re ready to sell your business.

There are also more introspective questions to consider.  What does this wealth mean for you and your family?   What kinds of opportunities will it create for you?  How does it relate to broader goals and dreams you have?  Do you want to dedicate a portion to philanthropy?  What causes are you passionate about?  Or are you planning for your next venture, and considering what investment you’d need for that?

We can help you frame key questions like these and model the impact of various choices you make.

2. Tax Planning

The tax impact of a liquidity event can be tremendous.  In the year of the sale, your income may skyrocket.  Dependent on the state in which you live, you could pay over 40% of what you receive in taxes.

Planning early, however, can help reduce the taxes you owe.

For example, if you are charitably inclined, you can consider a charitable trust.  Depending on the Section 7520 interest rates at the time you create your charitable trust, a charitable lead trust or charitable remainder trust may be more beneficial.  Both are irrevocable trusts that offer a tax deduction for the charitable donation.

In a charitable lead trust, a charity receives a stream of income for a period of years.  After that time elapses, the remainder passes to an individual beneficiary of your choice.

In a charitable remainder trust, an individual (typically the grantor) receives a stream of income from the trust for a period of time, usually for the rest of his or her life.  Afterwards the charity receives the remainder of the assets.

Your financial advisor and accountant work together with your estate planning attorney to determine which trust is right for you, and the attorney will create the documents.  There are many ways to structure these trusts to tailor them for your needs and situation, so be sure to talk to your team.

Simpler charitable giving vehicles can also be used to help offset your tax burden.  Donor advised funds (DAFs) are a great way to earmark funds for charity even if you aren’t yet certain which specific charities you’d like to support.  Because you get a tax deduction in the year you fund your donor advised fund, and your DAF can be designed to reduce your taxes.  You then have an indefinite number of years to make grants from your DAF to the charities of your choice.  This allows you to dedicate funds to philanthropy, reduce your taxes in the year of your liquidity event, and experience the joy of giving over time.

The structure of the sale itself can be uniquely designed to maximize the after-tax value of the sale.   A Business Tax Attorney can be valuable contributor around this topic to ensure the structure of the sale is as advantageous as possible for you.

3. Generational Gifting and Estate Planning

If your liquidity event will create a taxable estate, it is especially important to plan ahead for how to transfer your wealth.  Once you have a letter of intent (LOI) for your business, you have a defined business valuation.  Much of the value in estate planning happens when assets are likely to appreciate beyond their current valuation.  Therefore, estate planning is where it is most urgent to think ahead.

You will need to assess your family dynamics.  What level of wealth is there in excess of what you need?  If you have children or grandchildren, how much would you like them to receive?  What restrictions would you like to put in place based on their ages?  Are there other considerations that are important to you?

You will also face tradeoffs in terms of the control that you maintain over your wealth and minimizing taxes.  Many of the tax strategies that are helpful in business sales reduce control to varying degrees.  Typically, the more control you relinquish in these structures (to other decision makers or other beneficiaries), the more your taxes are reduced.   Various irrevocable trust structures like Grantor Retained Annuity Trusts (GRATs) can be used to ensure money is passed to your beneficiaries while mitigating estate taxes, but they do move assets out of your control.

Your financial team, especially your estate planning attorney, are critical partners in this conversation.

The earlier you plan for a liquidity event, the more likely it is that you will be able to protect and preserve the wealth you’ve worked hard to earn.  Please contact us if you’d like to talk more about your specific situation and how we can help you.



Read Now


Read Now
three team members from Dowling & Yahnke Wealth Advisors around a table

Retirement Plan Options for Small Business Owners: Defined Benefit Plans

Read Now


Discover the people who make Dowling & Yahnke one of San Diego’s top wealth management firm.



Our team is available now to discuss all of your financial goals.