The story: The Smiths, a 40-year-old couple with three children, ages 4, 6 and 9, sold a cloud computing company the wife started with her college roommate a decade ago. The deal, after federal and state taxes, netted the couple $28 million.
Ms. Smith agreed to remain with the company under a three-year consulting contract, but as a passionate entrepreneur, her mindset is to eventually find another start-up where she could make an impact. That means that she will need to ensure liquidity in whatever wealth management plans she makes.
Mr. Smith has been a stay-at-home dad, caring for their youngest child, a son with autism.
Their estate: Before selling the business, the Smiths were careful investors who had already accumulated $2 million in investment accounts. Their accounts included $1.2 million in a 1- 5 year municipal bond ladder, $300,000 in a “large cap” mutual fund and dividend paying U.S. equities, and about $500,000 in a money market. Most of their wealth was tied up in the company, an illiquid concentrated holding. (Their “new money” will be added to their current estate so as not to trigger capital gains taxes.)
Because they were diligent with their assets and spending habits, they have a manageable $400,000 mortgage on a four-bedroom home in Glencoe, which they will continue paying, and a summer home in Michigan that does not have a mortgage.
Their current estate: It has been 18 months since the Smiths sold the company, and their liquid net worth is now approximately $30 million. Ms. Smith still earns $500,000 annually as a consultant, and has 18 months left to complete her three-year commitment with them.
Regardless of whether she stays on for the rest of the contract period or leaves her position to start another company, the family has the following objectives:
• Maintain their current lifestyle.
• Establish a family foundation.
• Preserve their current capital base.
The plan: The family had a monumental liquidity event, seeing its illiquid assets go from $2 million to $30 million. Preservation of capital and generating income is important, but with an event that is as life-changing as the one they just experienced, if they were my clients my initial advice would be to park the sale proceeds in either a Treasury Bill or a safe, liquid bank deposit and let the dust settle three to five months immediately following the event, which they have done. This would allow us time to develop a solid investment plan to meet this young family's new set of goals, and help them grasp and understand the fortune they suddenly acquired.
Identifying an experienced wealth management team is a vital part of designing and executing a comprehensive plan. While the family has already been using a financial advisor, that person did not have the expertise to oversee a larger and more complex multi-million dollar investment plan.
Seasoned financial advisors who work with high net worth individuals usually have a good understanding of complex estate planning issues. These families may have several entities, such as revocable trusts, family limited partnerships,
generation skipping trusts, grantor retained annuity trusts and so on, and typically are worth at least $10 million.
If we were their advisors, we would help the family design an investment plan with the goals of meeting their income requirements and desire for an average growth of 6 to 7 percent annually.
Our initial investment recommendation would be to set aside $5 million in a family trust for their children. This is a very common strategy for wealthy families. The parent generation is using a portion of their allowable lifetime gift exemption now, so future growth of those funds occur outside of their estate and would not be subject to estate tax upon the parents' death.
In this hypothetical scenario, as per the couple's wish, we would set up $2 million in a family foundation that bears their name for any causes they would determine. This allows them to take a charitable tax deduction in the current year, while actually making gifts in future years. Moneys that are gifted to the foundation are an irrevocable gift. Again, this is what seasoned investment advisors need to know if they are managing money for wealthy families. Families with less than $10 million usually don't set up these entities.
We would also suggest opening trust accounts for both parents for the remaining $23 million. A portion of these accounts would allow the family to transfer more assets to the next generation estate-tax free.
Public investments such as stocks, bonds and mutual funds in general are very liquid. Investing a portion of their wealth in publicly traded, liquid securities allows them to access their funds quickly if they need it. Other investments such as real estate, hedge funds or private equity are not as liquid.
Of course, the asset allocation strategy we construct would be carefully balanced and monitored for risk, taking into consideration market conditions and performance.
In the end, by keeping their emotions in check and investing wisely with an advisory team, the Smiths could enjoy financial security for years to come.
Ben is Managing Director -- Investments at Hefter, Leshem, Margolis Capital Management Group of Wells Fargo Advisors. His areas of focus include global asset allocation, equity manager selection and fixed income portfolio management.
This case study is hypothetical in nature and is provided for informational purposes only regarding the services we are able to offer. This hypothetical case study is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Investing involves risk including the possible loss of principal. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. Please note that actual services provided may vary since each client situation is unique. The situation discussed may not be suitable for your personal situation, even if it is similar to the hypothetical example presented. Investors should make their own decisions based on their specific investment objectives and financial circumstances.
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