You've divested your stake. Now make the money work for you. Here's how

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Over the last decade, there has been an increasing trend in liquidity events for family businesses and new-found entrepreneurs. With a growing and vibrant venture capital and private equity industry and buoyant capital markets, clients often ask how to prepare for a liquidity event—ie an acquisition, merger, IPO, or any other action that allows founders and early investors to cash out some or all ownership shares. Prior planning can better prepare the family for the event. I believe, before making a decision, people have to look at it with both the head and the heart.

Through our rational thinking dominated by the head, we need to evaluate four key issues—taxation on the transaction and how to optimise for tax, the jurisdiction where the liquidity is being generated, the investment vehicles we should use from a post-liquidity event perspective, and how the proceeds of the liquidity should be invested.

The softer aspects of the heart are often much harder to address and centre around good communication between all family members and a need to maintain strong family ties through the process.

In my career, I have seen two kinds of liquidity events for clients—one where a family has completely exited a business and the other where there has been a partial exit. Complete exits from a business are much harder on families, often accompanied by an identity crisis as members of the family who were actively involved in the family business. This period of thinking “what next” for the second innings can often stretch to two to three years, and it is during this period that I have seen most family principals set up their family office.

The family office becomes an opportunity to learn a new set of skills, namely managing family investments and take the long view on wealth creation. It becomes a time to network and better understand newer and allied sectors that the family business has been involved in. It also becomes an opportunity for family members to become responsible custodians of wealth and to educate the next generation on the value of money and its force for good.

In all cases of a liquidity event, family principals are deeply concerned about the influence of the newfound wealth on the next gen, and that it should not create a sense of entitlement and stymie entrepreneurial pursuits. “Shirtsleeves to shirtsleeves in three generations” does play heavily on their mind. However, using the right investment structures, like trusts, can help address the circumstances under which the next gen can access their share of wealth—typically for entrepreneurial ventures, their first home, higher education, or unforeseen medical expenses. A growing trend that has been particularly encouraging is to see more women—be they spouses or daughters—involved in the discussions around a liquidity event. Decision-making has become much more inclusive.

Once the family comes into liquidity, I have always cautioned not to jump into investing immediately. Spend sufficient time on financial planning, understanding the long-term financial goals of the family as a whole and of the different family members. Wealth distributors eagerly scan the media for liquidity events and most families are not sufficiently conversant on the larger wealth management landscape or the subtle nuances between advisors and distributors to be able to tell the difference when they are approached by wealth management firms. My advice is to spend time understanding the different players, their strengths, and their capabilities; and to ultimately engage with a firm that works for you and who keeps your long-term interests at the heart of their advice.

There is no one silver bullet for the asset allocation of the investment portfolio and every family is different. You should arrive at your core investment portfolio after keeping aside monies for tax payments, repayment of debt, real estate purchases, and for philanthropic considerations. To preserve wealth for the longer term, it is important to have a strategic asset allocation and stay true to it. Asset allocation is merely a risk diversification tool, as different asset classes perform differently over varying periods of time with differing tax treatments. It is easy to get carried away, in markets like what we are experiencing today, to over-allocate to listed equities.

The best family offices keep the strategic asset allocation at the core and use tactical allocations to move plus-minus 10 percent off the stated boundaries. This is where governance comes in to manage a liquidity event. It is important to have a formal investment committee, comprising the key family members and independent external advisors to manage and monitor the portfolio. Equally important is a formal investment policy document to define the risk boundaries, which in many cases includes negative sector exclusions and integrating Environmental, Social and Governance (ESG) in decision making. Product allocations are the last consideration when creating a portfolio and as a rule of thumb, when you look at your portfolio you should be happy to hold 60 percent of the products for 3 years, 20 percent for 5 years, and 20 percent of the investments for the next 10 years.

A question often asked is if you should do your succession planning prior to a liquidity event. My advice is to treat these as two separate events. In some cases, prior to a liquidity event, you may want to transfer some of the wealth-generating assets to your children or grandchildren. This is fairly common, however broader succession planning will differ depending upon whether the liquidity event is triggering a complete or partial exit from the business. In the case of the former, it will involve the separation of assets while in the latter, finding a successor to run the family business will be the overarching theme of succession planning.

The author is the founder and CEO of Waterfield Advisors.

The thoughts and opinions shared here are of the author.