Liquidity Event

Derek Notman |

Personal financial and estate planning considerations for founders during a liquidity event.

Being a founder of a start-up, usually involves funding by venture capitalists and angel investors.  Ultimately, the big picture is to sell the start-up to a larger competitor or go public.  However, due to much effort spent on growing the business and preparing for a liquidity event, the founder’s personal planning is often not taken into consideration.

With the assistance of a Certified Financial Planner, a start-up founder can alleviate the risks associated with the investor’s equity by planning for the personal side of a liquidity event.  These risks are typically income tax, estate and gift tax as well as concentrated equity risk. 

Structure of a start-up

The majority of start-ups begin with an idea and a lot of support from family and friends.  There may well be a few founders and a small amount of capital contributed via various sources.  Sometimes the business looking for venture capital funding will form itself as a ‘C’ corporation.  This allows the business to take advantage of the tax benefits of qualified small business stock.

What does this imply?  Founders are issued restricted common stock, also referred to as founders’ stock.  This stock is subject to a vesting schedule, which is when founders agree that their founder's stock will vest over some period of time, usually four years. It is typical that all founders will have accelerated vesting of their founders shares in the event of a sale of the company.

Once the new business has grown and attained some success, it is able to attract funding from venture capitalists and investors.  These investors receive preferred stock, which has preferential rights to the common stock.  The percentage of ownership of the founders and employees is thus diluted and if the business continues growing, additional venture funding may be required.

The venture capitalists will eventually expect the business to be sold to a larger company or go public, with an acquisition of the business being far more likely than an initial public offering.  A liquidity event typically ranges from 5 to 10 years following the initial venture funding.  If all goes according to plan, the result is a large pay-out for the investors.

Liquidity Event Planning

Putting a team together

As founders are generally young and not wealthy, the importance of working with a Certified Financial Planner is vital in getting to grips with their personal financial affairs.  As the business increases in value, it is important to ensure tax returns are correctly filed and tax elections made timeously.  Estate planning is just as important as founders need to be covered for unforeseen circumstances. 

The significance of financial planning

A financial planner will assist you, as a start-up founder with your personal planning anticipating a liquidity event.  A sound financial plan starts with the long-term financial goals of the founder.  When the goals have been outlined, the plan determines cash flow requirements going forward which can include things like:

  • Liquidity needs - which is basically the assets needed to maintain your lifestyle.
  • Longevity planning - essentially how to manage your new wealth to last a lifetime and longer.
  • Legacy planning – how to best hand gifts/inheritances to family and friends, or philanthropic contributions.
  • Giving back to the startup community – how to invest in young companies like yours once was while balancing it with the rest of your finances.

A well thought out financial plan, in concert with your tax and legal advisors, will assist you as founder to manage restricted stock and equity compensation, including understanding company transfer restrictions, tax elections and liquidity necessary to pay taxes on equity transactions.

Finally, the financial plan can address single stock diversification strategies and inform a proper investment strategy based on the founder’s risk tolerance after the founder has become liquid.

Estate Planning

Given that founders are young, estate planning is not usually a priority.  That is not say that start-up founders don’t have significant paper wealth, as most do.   The complication arises when there is no will in place to unintended individuals including Uncle Sam.  For example, If the stock is illiquid (an asset that is not easy to sell and exchange for cash), paying the tax may prove problematic

As a source of liquidity for estate taxes life insurance should be considered.  Also, if the founder is married, life insurance may be required to provide income replacement for the surviving spouse until the start-up shares become liquid.

A variety of legal documents should also be considered with an experience attorney to set things up like revocable living trusts, durable powers of attorney and appointment of healthcare agents and directives as they are essential to a good estate plan.

After the Liquidity Event

Transfer restrictions and hedging or pledging public securities

Seeing the end of a successful liquidity event may be halted by corporate lock-up agreements and securities law requirements.  Public stock received in an IPO (Initial Public Offering) or an acquisition is typically subject to a lock-up period (imposed by the underwriters in the case of an IPO and the acquiring public company in the case of an acquisition) of up to 180 days before the stock is permitted to be sold.

A pre-established trading plan should be considered by founders, as most companies impose restrictions on insider trading, hedging and pledging shares by executives.  The trading plan should comply with SEC Rule 10b5-1 to avoid violating corporate policies or securities law.  Finally, SEC Rule 144 provides a safe protection from registration of certain securities so that an employee may sell securities in a public market place.  No matter the situation make sure to consult with a team of advisors.

Concentrated equity planning

There are a variety of concentrated stock strategies in addition to outright sale that can alleviate the risk of a concentrated stock position, assuming transfers, hedging and pledging of public stocks is permissible.

Charitable planning

Being philanthropic and setting up charitable planning in anticipation of a liquidity event is a tax-efficient way to offset some of the taxes in the year of the liquidity event.  Compared to pre-liquidity charitable planning, post-liquidity charitable planning is a straightforward process.  A founder could receive cash, public stock or a combination of cash and public stock.  Cash gifts are deductible up to 50% of the adjusted gross income in the year of the gift, with a 5 year carry forward.  When gifting the stock to a public charity or to private foundations, which are deductible at fair market value for public stock, any income tax on the built-in capital gains on the stock disappears.  All charitable vehicles are available post-sale, including outright gifts to public charities (including donor advised fund), gifts to private foundations, and gifts to charitable remainder and lead trusts.

Investment/financial planning

Working with a Certified Financial Planner, the founder should update the financial plan with the actual dollar amounts upon conclusion of the liquidity event.  It is important to take into consideration taxes that may be owed on the liquidity event.  Once the financial plan is updated, the founder will be able to determine which of the three categories (from above) the net worth should be divided into.

Your Certified Financial Planner can help you put a proper investment strategy together and the financial plan should be updated annually to reflect markets, changes in circumstances and any necessity to move assets among the categories.


Qualified small business stock

If after liquidity, the stock is considered qualified small business stock (QSBS), there are some income tax saving and deferral opportunities available.  QSBS is stock in a small, domestic C corporation that operates an active business. To qualify, the corporation must use at least 80 percent of its asset value in the active conduct of one or more qualified trades or businesses (certain industries are excluded) and the gross assets of the corporation, as of the date the stock was originally issued, can’t exceed $50 million.


Depending on when acquired, the seller may exclude between 50% and 100% of the gain on the sale of the QSBS. To qualify, the QSBS must be held for at least five years prior to the sale, and the shareholders must have acquired the stock at its original issue, in exchange for money or property, or as compensation for services rendered.  Additionally, on the sale of QSBS, if held more than six months, the seller may elect to defer realized gain by reinvesting the sale proceeds into a new QSBS investment within 60 days of the sale.  The seller’s basis in the replacement stock is reduced by the amount of the gain deferred. This ensures that gain continues to exist, but is merely deferred.  Working with an experienced tax professional is key to making sure you work through this strategy correctly.



Life After A Startup

Although the financial transition a founder goes through is important to plan for during a liquidity event it is also equally important to plan for the emotional transition you will go through.

All of a sudden you are no longer the founder of your startup, your baby.  You go from working around the clock to each day being a Saturday.  While this transition can certainly bring some peace and relaxation with it, it also will bring challenges.

  • What is your purpose now?
  • What do you do with all your extra time?
  • What is your self-worth now that you are no longer running a company?

The startup life is fast paced, although some moments can seem to last forever, it is stressful, you can be elated one day and the next wondering how you are going to make payroll.  Regardless of the ride, you are still on the ride.  When it ends, and it always does, what will you do?  Spend some time to reflect on what is important to you, speak with your family and friends about these things, and revisit them from time to time, it will be very helpful to prepare you for life after the startup.

Thank you for reading!


Derek Notman​