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Importance of Financial Wealth Planning for Executives of Start-ups

Like the companies they work for, executives of start-up companies face unique and complex financial challenges. Unlike their peers who work for publicly traded companies, executives in start-ups understand that survival is the first order of business. Seldom is there enough working capital to go around, and as a result, cash compensation falls to the bottom of the company’s priority list when it comes to resources. Research and development and other start-up costs usually take priority, even in the face of a need to attract first-rate talent.

So, as an executive facing these challenges, what should you do and how can a financial advisor add value? Engaging an advisor to start financial wealth planning early is the best way to maximize your returns and preserve the wealth that you’re working hard to produce.

Here are some specific areas where engaging a seasoned advisor can really make a difference:

Equity compensation –researching and understanding the details of the offer

Equity can vary, and some equity offers might suit certain people better than others; thus it is essential that you understand the provisions. An advisor can help you to analyze and evaluate its potential impact on your financial situation, which goes a long way toward making the best decision for your long-term goals. Some equity compensation offers may include:

  1. Restricted Stock Award (RSA) –

    A type of restricted stock. Upon receipt the executive immediately becomes a shareholder with voting rights. Things to keep in mind:
    1. Executive owns the stock as soon as it is granted but has to provide payment to purchase the RSA shares at grant date, and the shares may be forfeited in the case of early departure or failure to meet performance or sales goals
    2. Taxed as ordinary income upon vesting (Fair Market Value [FMV] less any amounts paid for the awards)
    3. Taxed upon grant if executive makes a Section 83(b) election; subsequent appreciation taxed as capital gain
  2. Restricted Stock Unit (RSU) –

    Simpler than RSAs, RSUs are compensation. No payment required, and shares are not issued until vesting is complete. They are an effective long-term incentive tool, as employees are incentivized to stay with the company longer. It is important to note:
    1. No shareholder voting rights until vesting is complete
    2. Vesting may also be tied to individual or corporate performance goals
    3. Taxed as ordinary income upon vesting (FMV less any amounts paid for the units); shares are generally withheld for taxes)
    4. Not Section 83(b) eligible
  3. Stock Options –

    Stock options give the holder the right (but not the obligation) to purchase a fixed number of shares of employer stock at a fixed price, over a stated period of time. There are two types:
  1. Non-Qualified Stock Options (NSOs) –

    Defined as any option that does not meet the test for an Incentive Stock Option (ISO).
    1. NSOs may be granted to an executive, an executive’s family member, or any other beneficiary of the executive
    2. Upon exercise NSOs are taxed as W-2 income and subject to payroll taxes for the difference between FMV and strike price
    3. After exercise, taxable basis is the exercise price plus the ordinary income recognized (approximately equal to FMV on date of exercise)
    4. Sale of shares acquired through the exercise of NSOs result in a capital gain or loss, the character of which depends on the holding period
  2. Incentive Stock Options (ISOs) –

    An option that meets the IRS requirements for special tax treatment. Under the right conditions, ISOs can result in lower taxes for the executive. The preferential treatment has strings attached, however:
    1. Must be part of a written plan approved by the stockholders and may only be granted to employees
    2. There is an annual limit of $100k on the value of ISOs granted during one year to a single employee
    3. Must be exercised within 3 months from date of retirement or termination (else it is treated as a NQSO)
    4. Shares received via ISOs cannot be sold within 2 years from date of grant or 1 year from date of exercise, otherwise, favorable tax treatment is lost

Investment planning — executives can sometime have competing objectives

On one hand executives want to preserve and protect capital, and on the other they also want to grow their portfolio. In working with a trusted advisor, you can develop a strategy that strikes a balance.

To incorporate your equity compensation into a financial plan, an advisor should take into account your:

  1. Risk tolerance –

    This can be a function of time horizon and age, and it could reflect a comfort level in wide swings in the price of the company stock
  2. Time horizon –

    How much time do you have before the need to realize benefits? - When the options vest, when you own the stock, when the benefits expire, how long you plan to stay with the company…? The answers to all of these questions can influence the time horizon.
  3. Price target –

    Targeting multiple prices allows you to benefit from rising prices, but also offer dollar cost averaging to protect from downside risk
  4. Liquidity needs –

    How much is needed and when? Shorter-term goals may require lower risk and higher amounts of liquidity.
  5. Willingness and desire for diversification –

    Owning too much of one asset is risky, particularly when your objective switches from growth and accumulation to preservation. This is even true when it’s the stock of a company you know very well.

Personal cash-flow — budget, budget, budget

Advisors can really earn their salary with their clients by helping them to navigate changes in their cash position. Given the modest cash compensation for executives of start-ups, it is critical to have a budget in place to cover living expenses, debt service, and major expenditures.
In addition, an advisor will need to develop a strategy for raising cash that weaves into your equity compensation plan. At critical times cash may need to be raised in order to exercise options and/or awards, which could involve the use of personal debt, such as a margin loan, an asset-based loan, or even a mortgage.

Other important financial wealth management items to think about

  1. Qualified Small Business Stock (QSBS)

    Imagine owning stock in a start-up where the price appreciates greatly, you sell it, and pay no tax on the gain. And because it is permissible to issue QSBS in exchange for services, it can be a useful tool for startups and other companies short of cash to compensate employees. For more information on QSBS, read our article, Entrepreneurs & Executives: 5 Personal Wealth Items You Need to Be Thinking About.
  2. Estate planning — not just for the ultra-wealthy

    Three basic estate planning documents (will, durable power of attorney, healthcare proxy) will help ensure your wishes are followed upon your death. It is important to execute these documents and keep copies with a personal attorney and executor. Read our blog here, to dive deeper into the basics of estate planning documents.

Conclusion – hire an experienced financial advisor

Working at a start-up is demanding; its fast pace and long hours can wear on an executive and make it extremely difficult for them to find the time to manage personal finances. Partnering with the right advisor, one that not only understands the challenges executives face, but has the experience to navigate them, can enhance the windfall for an executive of a start-up.


Lake Street Advisors – Trusted Partner of Entrepreneurs and Executives

Lake Street Advisors has been providing wealth management and legacy planning for entrepreneurs and executives since 2003. From years of working with founders, CEOs, and early investors, they have significant experience with financial strategies unique to early-stage and growth-stage companies.

If you would like to review any of the items discussed in this article, or explore how an advisor could bring value to your financial wealth management, please don’t hesitate to reach out.




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