Yet, tax reduction is only one of the key estate-planning considerations following a liquidity event. Legacy-related and family-governance considerations may also be quite important. Some individuals will want to create family LLCs not only to facilitate the potential for discounted gifting but also to offer a structure for managing the family’s substantial and growing wealth – and even its legacy. Some will also want to consider the creation of family foundations, charitable trusts, or donor-advised funds so as to offer a clear, collaborative structure for achieving the family’s philanthropic objectives. A donor-advised fund or family foundation that fosters collaboration provides an excellent opportunity to share values and educate the next generation on financial responsibility, thus helping to ensure effective wealth transfer to future generations.
3. Investment Asset Allocation and Portfolio Rebalancing
a. General
A liquidity event, by definition, will change an individual’s overall asset allocation mix. Moreover, it could change the individual’s short- and long-term goals and needs, as well as impact the individual’s risk tolerance, time horizon, tax status, and other factors.
In turn, the individual will need to go through an intensive process first to establish a new investment policy (preferably in writing) and then to undertake a reallocation and rebalancing process. Diversification will remain important, but larger account values may generate opportunities to access investments, managers, and asset classes (e.g., certain alternative investments, private equity, and other private strategies) that previously may have been unavailable, thereby necessitating a completely fresh, opportunistic look at all portfolio strategies.
b. Publicly Traded Securities
Managing portfolio risk where an event includes the receipt of publicly traded securities often involves the potential additional complexity of securities regulations, company policies, and, of course, contractual arrangements. Diversification planning may include a host of arrangements, including trading plans, hedging transactions, liquidity arrangements, and income-enhancing techniques. Coordinating with tax advisors and counsel, as well as negotiation with investment banks, is critical.
4. Cash-Flow Planning
Despite the fact that a liquidity event will result in the conversion of one or more assets into cash, the event nevertheless may generate a need for a different approach to cash-flow planning. In many cases, for example, a business sale is accompanied by a reduction or elimination of traditional compensation income. In turn, it often is necessary to adjust the composition of an individual’s investment portfolio to produce levels of base cash flow sufficient to support the individual’s lifestyle and needs (which also may change after the event).
Other cash-flow considerations may include determining the best after-tax approach for dealing with any outstanding debt. Mortgage, investment, and business debts should be reevaluated in light of the cash infusion, possibly leading to whole or partial payoffs, which, in turn, require incorporation into the cash-flow plan.
5. Risk-Management Planning
a. Insurance
The realization of a liquidity event also requires a complete reevaluation of the insurance spectrum covering the risks faced by an individual. Most obviously, a substantial liquidity event may obviate, or at least change, the need for continued life insurance. Business-related insurance also may need to be changed, particularly in the context of a business sale.