As an angel investor, you have spent a lot of time growing your own business and then lending your expertise to help other entrepreneurs. That hard work has enabled you to increase your net worth but oftentimes means that a large portion of that net worth is illiquid. What if something were to happen to you? Would your family know how to value your business interest(s)? Would they have money to pay for estate and income taxes? Who would control the interest(s) in your various business investments?
These are real issues that can leave families struggling for liquidity while arguing over succession planning strategy. Having a plan in place to assist with the smooth transfer of assets upon your death is important when the assets you hold are not easily marketable. Therefore, here are a few tips we believe will help you create an estate plan today that will work to keep the wealth you have created in your family.
1. Annual Meetings of your “Brain Trust”: At Stratus, we like to have an annual meeting with our client’s various service providers (e.g., accountants, lawyers, business partners, etc.) so that everyone is aware of major developments and can share any concerns they have with the key advisers and decision makers. Below are a few questions we try to answer at each meeting:
a. Who will value your business interest(s)? Do you have a control or minority stake in these businesses and how will that impact the value you receive? What are the restrictions on the sale of your ownership interest and how will that impact the value you receive?
b. What new tax regulations are pertinent to your business and how do these affect your short- and long-term planning?
c. Are all your contracts with employees, vendors, etc. up to date?
d. Who, if anyone, will succeed you in your business? Who will own your stakes in any other businesses or business investments?
e. If you have children that are interested in the family business is it time to bring them on as an employee? If so, at what point do they begin to acquire an ownership stake and how is that stake valued and paid for?
2. Life Insurance: Angels investors don’t fit a typical profile or age cohort, but life insurance can be an important liquidity tool for any angel investor. We suggest setting up your estate planning documents carefully so that insurance proceeds will be available to your spouse first (if applicable) and then to settle your estate.
a. Younger Investors: How long would you like to protect against the risk of illiquidity? Periods under 20 years are typically associated with term life insurance whereas the most beneficial protection over longer periods may be cash value insurance such as whole life.
b. Older Investors: What is your life expectancy and allocation to private businesses? In general, shorter policies, such as 10-year term insurance, may provide the liquidity protection you need while keeping premium payments relatively low. Investors with lower allocations to start-ups and/or those who have more stable sources of cash flow may want to purchase cash value life insurance, such as 10-pay whole life, which front loads policies with larger premiums over a finite period (e.g., 10 years). These policies can provide the dual benefit of liquidity during your life and liquidity following your death.
3. Family Trusts, Partnerships and LLC’s: We believe that it is important for angel investors to use legal entities to either hold their current businesses and/or investments or to create provisions for these assets to flow in to legal entities upon their death. Different kinds of legal entities fit different scenarios but having a discussion with your “brain trust” can help you set specific parameters for how your assets are distributed and who operates them after your death or if you become incapacitated.
4. Loans Between Trusts: Many trust documents allow for loans between the different trusts that are created as part of your estate plan. We highly recommend that these provisions be included in any angel investor’s estate planning documents. This can allow for money to be loaned from a more liquid trust to the deceased’s estate to pay taxes, liabilities and other final expenses.
5. Letter of Intent: We only suggest pursuing a letter of intent in very rare circumstances. Angel investors who are heavily exposed to illiquid investments can work with one or more of their portfolio companies to set parameters for selling shares back to the company should the angel suddenly die or become incapacitated. These letters of intent can create liquidity in an emergency but typically at a discount, so it is necessary to review these documents on an ongoing basis to see if they are still relevant given the angel investor’s current financial situation.
While never the most fun process, spending time today personalizing your estate plan and subjecting that plan to an annual review will greatly enhance the legacy you leave for your loved ones.