Executives may not be able to sell their corporate stock holdings due to company or regulatory restrictions.
However, there are ways to unlock funds without incurring major tax bills.
Parts of your business may be doing less well, potentially generating taxable losses to offset gains. There are similarly numerous vehicles that can offer tax efficiency, including exchange-traded funds, charitable trusts, and foundations.
Exchange or ‘swap’ funds enable investors to exchange large holdings of a single stock for units in a portfolio without producing immediate capital gains. These funds have several advantages: funds typically manage companies in a wide range of sectors and control the entry of new investments if their holding becomes unbalanced.
Drawing on salary or dividends
If your business generates cash, drawing on it to diversify can be a good option.
More mature companies may create fewer compelling opportunities for which returns exceed the cost of capital. At this point, taking dividends and investing in the market may produce a better outcome.
Executives holding stock also may not be able to spend dividends until the stock vests.
Tax efficiency remains an issue, though, since dividends and income are subject to taxation in many jurisdictions. But you do not need to generate a large capital gain through this method.
Borrowing
Entrepreneurs are often accustomed to using debt. It may have played a significant role in building their business.
While many traditional savers focus most on the risks of borrowing, entrepreneurs recognise the opportunity to earn returns in excess of the cost of debt. And when their company is growing fast; borrowing can prevent them from having to sell.
Entrepreneurs can use several types of borrowing to fund diversification. They can borrow against property or against other physical assets. They can also borrow against a single stock.
Borrowing against assets entails risks.
Entrepreneurs should carefully calibrate their debt against a number of factors, including the volatility of the assets they borrow against, the borrowing term, and the path of interest rates.
Executives may similarly face restrictions on borrowing against their stock or options.
What diversification looks like
Having released capital to construct a more balanced portfolio, entrepreneurs will need to consider what this will look like.
This could mean diversifying their business itself by buying another venture. In an ideal case this could create a second fortune, but may also introduce a new set of idiosyncratic risks.
Holding liquidity is important for entrepreneurs, as they typically require more than the average investor in their pursuit of opportunistic business projects. We recommend that business owners hold three to five years’ worth of lifestyle expenditure in liquid assets, but no more.
