Charitable strategies for advisors facing their own liquidity event
By Jesse W. Hurst, CFP®, AIF®, Financial Advisor and CEO of Impel Wealth Management and Lewis E. Bennett III (Trey), Partner, Stark & Knoll Co. L.P.A.
In high school, many of us were asked to solve a word problem that went something like this:
Two trains leave stations 288 miles apart at the same time and travel toward each other. One train travels at 75 mph while the other train travels at 85 mph. How long will it take for the two trains to meet?
Financial advisors and wealth managers are facing their own multi-variable math problem as they look toward their future and their retirement. The first variable is the inevitable marching on of time. According to a recent J.D. Power study, the average age of a financial advisor in the United States is now 55, and approximately 1/5 of advisors are over age 65.
As these advisors continue to move toward retirement, many are trying to figure out the best way to maximize the value of their practice. Many of our friends who work in employee models in national wirehouses, banks or insurance companies have seen their firms create internal continuity and succession platforms. These are designed to create both a benefit to the employee advisor and to retain assets on the platform of the current company – a win-win proposition.
To those of us living in the independent advisor world, it is up to us to create a plan to maximize the value of our practices and to provide continuity of service to our valued clients. Most independent advisors find that the bulk of their net worth has been built in three assets: their homes and real estate, their retirement and investment accounts, and the value of their advisory practice.
This leads us to our next variable: How do we value our practice, and who do we consider selling to or partnering with to accomplish our dual objective of maximizing value and creating succession for our next generation of advisors and clients? For many years, advisory firms were valued based on a relatively modest and consistent multiple of either recurring revenue or EBITDA. There was some advantage to growth and scale, as larger firms were able to command higher multiples.
However, over the last five years, a number of private equity firms realized that well-run, independent advisory firms generally have profit margins that would make very attractive investment targets. This realization, along with historically low interest rates, gave PE firms the ability to borrow money cheaply to acquire full or minority ownership in advisory practices. This combination of low interest rates and high profit margins has led to valuation multiples expanding to levels that many advisors would never have thought possible only a few years ago.
As a result, another key consideration for advisors facing a liquidity event is how charitable planning fits into the equation.
Most advisors will spend their career advising clients before, during and after liquidity events; however, everything changes when the PE firm approaches the advisor about the sale of their advisory practice. Now, instead of the one counseling the client, they are faced with taking the critical and time-sensitive steps of implementing a highly effective and impactful philanthropic strategy that allows them to minimize taxes while also making a difference for the causes they support.
When first approached for sale, there is the excitement that comes with the potential financial windfall of capitalizing on your life’s work and dedication to your clients, but there is typically also the quick realization that your life’s work started from scratch and will come with a corresponding large capital gain. This is where the advisor’s advisor will remind them of all the clients they referred to Akron Community Foundation over the years that were experiencing liquidity events, and how those clients were able to achieve a charitable tax deduction for the fair market value of the donated interest and capital gains minimization for the portion donated and sold by Akron Community Foundation.
While the advisor may be familiar with the process, having walked numerous clients in similar situations through it before, it still is beneficial for them to be reminded of the following simple charitable giving strategy.
Advisor A is selling her advisory firm, which has an appraised value of $10 million. From the sale proceeds, Advisor A wishes to donate $2.5 million to her favorite causes through her donor-advised fund at Akron Community Foundation. If Advisor A were to sell the stock before implementing her charitable strategy, the final gift to her donor-advised fund would be $1.9 million, she would have paid $595,000 in taxes on the $2.5 million she wished to donate, and she would have avoided $704,850 in taxes1. While not a bad outcome, if, instead, Advisor A were to implement her charitable strategy before the liquidity event by donating a $2.5 million interest in her advisory practice to her donor-advised fund at Akron Community Foundation prior to signing the purchase and sale agreement, the final charitable gift would be the full $2.5 million, she would pay $0 taxes on the charitable gift, and she would have avoided $1.5 million in taxes2 (i.e., $595,000 MORE would be given to her donor-advised fund, and $815,150 LESS would be paid in taxes). Therefore, this seemingly simple strategy would allow Advisor A to save a total of $1.5 million and increase her donor-advised fund by 31%, allowing her to make an even greater charitable impact in the future.
This is just one of the charitable strategies that could be implemented when going through a liquidity event, so communication with your advisors is key, and getting Akron Community Foundation involved early in the process can allow you and your team to navigate the various unique opportunities that are available. Therefore, even advisors, having gone through this many times on the advisory side, still need to slow down the speeding trains, put things back into perspective, and implement a plan to make more impactful gifts while achieving their financial and legacy planning goals.
1 This hypothetical example assumes a 37% marginal income tax rate and a capital gains rate of 23.8%, inclusive of a 3.8% Medicare surtax. It also assumes that Advisor A’s business interests have been held for longer than one year, and that she has zero cost basis in the stock. Finally, this sample calculation does not include the discount rate that is applied in the valuation of a closely held corporation.
2 For ease of reading, these figures are rounded to one decimal point. The full calculation of the final donation following the sale of a business is $1,905,000. The tax avoided in the scenario where the donor contributes shares of the business prior to sale is $1,520,000.
Jesse Hurst, Financial Advisor: Securities and advisory services offered through Cetera Advisors LLC, member FINRA/SIPC, a broker/dealer and a Registered Investment Adviser. Cetera is under separate ownership from any other named entity. Registered office address: 2006 4th Street, Cuyahoga Falls, OH 44221. The charitable entities and/or fundraising opportunities described herein are not endorsed by or affiliated with Cetera Advisors LLC or its affiliates. Our philanthropic interests are personal to us and are not reviewed, sponsored or approved by Cetera.
This content is provided for informational purposes only. It is not intended as legal, accounting, or financial planning advice.