As the COVID-19 pandemic continues to unfold across the United States, many pending transactions are stalled due to the attention on the urgent crisis. The impact to portfolios and businesses is catastrophic for many. However, disruption like this can represent opportunities in certain areas. Below is a brief overview of two key opportunities that should be considered for companies, advisors, and their clients.
Estate Planning-Gifting of Equity
In truth, historic mayhem like today makes effective asset protection a crucial part of any well-developed estate plan. For high value estates, an environment with depressed asset values can be the exact right time to move assets. Additionally, volatility and uncertainty in the market tends to bring into focus the need to have an effective and updated estate plan in place.
Currently, the lifetime gift and estate tax exemption are at an all-time high of $11.58 million per individual and $23.16 million for a married couple. When values are down, more volume of equity ownership can be gifted under lifetime gift limitations while eliminating or lowering gift tax. This is particularly enticing to family owned businesses looking to transfer wealth to the next generation. Under the current laws and regulations, when a family business owner transfers an interest in their business to another family member, the value of the transfer is recorded at fair market value. Given the current economic climate, it is likely a larger share of equity interests can be transferred at a significant discount.
409A and Profits Interests
Companies that grant stock options to their employees must do so in compliance with IRC 409A. This requires at least an annual valuation and periodic valuations when a material event occurs, typically company specific. Today, the abrupt decline in equity values coupled with the high degree of economic uncertainty could constitute a material event for virtually any company. Add to this the fact that many companies will have company-specific challenges they are now facing.
As a result, it is easy to justify conducting a new valuation that locks in a lower strike price for the next twelve months for options granted to employees. Previous grants that may be upside down could be negated and replaced with a new grant at a more beneficial strike price to employees. By making the new grant vesting schedule equal in vested amount to the grant they are agreeing to cancel, the employee is made whole. Obtaining a new 409A valuation can be a significant benefit to the employees when the company eventually a reaches a liquidity event.
The same is true of many private equity-backed companies that may be in an LLC structure and providing key team members with profits interests grants. A new valuation can be conducted to establish a lower threshold for profits interest grants. In these circumstances, it is more likely than not that the cost of valuation relative to the benefit to team members is apt to be a great trade-off.
Although this is not a strategy for everyone, if you were considering these transactions before the emergence of COVID 19, this is the time to take advantage of the market and economic environment to ensure the house is in order. If you have any questions about these potential opportunities, make sure to reach out to your accountant or financial advisor.