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5 Strategies to Diversify Concentrated Stock Positions

By: David Goldner

Business owners and executives pour their hearts and souls into building a successful company. Often their hard work and dedication pays off, quite literally, with the sale of the business to a publicly traded company. Those corporate executives and their families end up with the majority of their wealth tied up in a single asset — the stock of a publicly traded company.

While the wealth you accumulate from the stock can be substantial, a concentrated stock position presents several problems, namely, that there is risk associated with tying all of your wealth to a single company. Sure, you can sell the stock, but this can result in a big tax liability. So what do you do?

Let’s look at how you can better manage your family’s wealth by diversifying your concentrated stock position.

Get Emotion Out of the Way

Let’s say you’ve accrued a concentrated stock holding because you sold your business to a publicly traded company ten years ago. You’ve enjoyed watching your wealth grow substantially over the years.

If you’re like many people, you have a real personal attachment to the stock because it’s the primary source of your family’s wealth. Your feeling is that, “This company helped build my assets and it is part of my legacy, so I want to participate in its continued success.” In addition, you’re thrilled because as you’ve watched your wealth grow, you’ve avoided income taxes simply by not selling the stock.

It’s all good, right? Well, yes and no. While the stock has grown your family’s nest egg to a nice size, any emotional attachment you have to the stock has likely been a roadblock when it comes to effective tax and financial planning.

Diversifying your concentrated stock position makes sense when it comes to minimizing risk and taxes. But to accomplish those goals, your emotional attachment to the stock can’t get in the way.

Consider Various Strategies for Diversifying Your Concentrated Stock Position

There are steps to take and plans that should be put in place to accomplish all of your family’s financial and personal goals.

Your first step should be to determine a minimum goal for your family wealth. For example, if your family has a $100 million CSP, ask yourself, “What is the minimum amount of wealth my family would want, assuming any risk that the CSP value would drop to zero?” Let’s assume the plan is to create at least $25 million of wealth outside of the CSP. This is your first step toward diversifying.

One choice is a simple sale of about one-third of the stock position. This will, in a straightforward and uncomplicated way, create the wealth you need, net of taxes. This will provide the peace of mind you need to secure your family’s financial future.

Another choice is to enter into a hedged transaction. A number of different strategies are available to create your family’s wealth outside of the concentrated position. Let’s look at those options. 

  1. You can create an equity collar to lock in the value of the stock within a certain range of value, allowing a range of potential future value. An equity collar places a cap on upside potential, while limiting downside risk at little or no cost. This is accomplished by selling a call and buying a put to lock in value.

  2. A variable prepaid forward contract (VPF) allows a taxpayer the right to sell stock in the future at a fixed price — locking in that value but deferring the income until the closing out of the contract. The contract usually allows a withdraw of up to 90% of the asset value that can be used for diversification of the position.

  3. An exchange fund, often sponsored by a brokerage, allows the contribution of some of the CSP and in exchange provides the owner with a diversified position in various types of investments.

    Two other methods of diversifying a CSP is to incorporate your family’s charitable goals into a plan to create a private family foundation or charitable remainder trust

  4. Set up either a private family foundation or a supporting charitable organization. These vehicles allow a family with a sale of stock to offset between 20-30% of the tax liability with a direct charitable contribution of the appreciated security. Your family will then have funds to be used for charity to achieve other long term personal and social goals, over a timeframe that your family controls.

  5. Set up a charitable remainder trust (CRT) where you contribute a portion of the concentrated stock position and then sell the remaining position. The sale is not currently taxable and the trust will provide income for your family either for a period of years or for life. As a bonus, when forming the trust, you generate a significant income tax deduction for a percentage of the assets put in the CRT. This deduction can be used to offset a direct sale of stock that can help in your overall diversification plan.

Which Diversification Strategy is Right for You?

The short answer is that there is no one best method to diversify a CSP. Identifying and formalizing your family’s goals, with the help of a wealth management professional who has solid tax expertise, will result in a plan for strategically managing your family’s wealth while minimizing taxes.

Need Help?

Contact us online or call 800.899.4623.

Published November 1, 2016

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