For many owners of privately held companies, selling their business represents the culmination of years of work and offers the prospect of financial security for life. Our experience has shown, however, that without strategic financial planning prior to the sale, an owner may not realize its full potential. By defining personal objectives and putting a few key strategies in place, an already lucrative transaction can become a golden opportunity—without slowing down the sale process.
Bernstein has developed an analytical framework designed to identify the critical alternatives when selling a business. By integrating potential deal terms, key tax- and estate-planning strategies, and the business owner’s financial goals, the owner and his team of advisors can, we believe, most effectively extract maximum value from the deal. While the model is best used on a personalized basis, our research has uncovered some global themes:
• The sale of a business often allows the owner’s spending, legacy, and philanthropic goals to be met—but not always, particularly if strategies to meet them are not mapped out at the beginning. The solution is to ensure that sufficient assets will be set aside to address the owner’s top financial priority (often his spending needs), and then work out plans for meeting his other critical needs—all prior to the sale.
• Generating the most value from a transaction is not necessarily tied to finding the highest sale price. Often, the maximum benefit can be gained by making a few critical decisions in advance. These decisions include:
■ Weighing the safety of cash against the tax deferral and greater return potential of a stock transaction. A stock deal may seem more lucrative, but its additional risks need to be factored in, including exposure to price fluctuations before the deal is consummated and the imposition of a lockup period.
■ Evaluating key estate-planning strategies, which often yield maximum benefit if implemented before rather than after the transaction.
A careful evaluation of the owner’s goals and anticipated sale proceeds can help determine the types of family or charitable trusts to establish— whether to use a GRAT, a CRT, or both, for example—and the amounts to allocate.
■ Considering various exit or liquidity strategies other than a straight
100% sale—such as the sale of a minority stake in one’s business, a leveraged recapitalization, or sale to an employee stock ownership plan.
Key financial-planning questions arise with these strategies, including how much of the owner’s stake to sell.

Personal Objectives Shouldn’t Take a
Back Seat
In the high-stakes environment of a sale— evaluating offers, trying to close, overseeing the interests of the company and the employees— business owners feel pressure to focus their efforts on the critical business issues, asking themselves questions like:
What is my business really worth?
What is the right deal structure?
How do I make sure the deal closes?
These are all key questions that must get addressed by the owner and his deal team. Often it’s not until after the sale closes that the owner addresses more personal concerns:
Did I get enough to meet my financial objectives?
What estate and trust strategies should I consider?
How should I invest my financial assets?
But it’s crucial to address these questions before the deal—or the owner risks leaving very large sums of money on the table. By bringing his personal financial goals up front, he provides his team of advisors with the information needed to tailor the transaction properly. This is not only a business proposition, but a personal one—complicated by the fact that it can take many paths. What may be surprising is that such preparation before the transaction doesn’t have to be onerous; the main thing is for the owner to take those first steps.
Complexity Is Manageable
This study starts with a discussion of setting goals, prioritizing them, and quantifying the likelihood of achieving them. These goals are then considered in an evaluation of deal terms— because some deal structures are better suited than others to meet certain personal objectives, and often can be modified to fit the owner’s needs more closely and with less risk. Further, because business sales offer a great opportunity to shore up one’s family or philanthropic legacy, we highlight the value that different trust strategies can add, particularly when considered prior to, rather than after, the transaction. We conclude by evaluating the financial-planning issues that arise when an owner considers selling less than 100% of his business because he’s unwilling to give up control completely or because he’s gradually preparing for an inter-generational transfer.
The foundation of much of our analysis is a proprietary wealth forecasting model that integrates capital-markets behavior (based on history and research-derived projections) with the owner’s individual circumstances.
While the size of the transaction is, of course, critical, we focus throughout our study on extracting the maximum benefit for the owner, given his unique situation, regardless of the deal amount. In our view, this approach not only helps create the best deal for the business owner, it also helps make deals happen in the first place.
2. SETTING GOALS
An investor’s goals for his wealth can comprise a long, complicated list. Yet, when reduced to their essentials, there are really only four things people can do with their money: spend it; give it to the people they care about; give it to charity; or send it to the government in the form of taxes. Some of these goals will be in competition with others, so a business owner must weigh his priorities: Is a more luxurious lifestyle the priority, or starting a new business? Passing on a large legacy to his heirs, or establishing a charitable foundation? Should he stay involved with the business, for example, or get out—or something somewhere in between? Such decisions will naturally be major drivers of the strategies adopted.
Address Spending First
For most investors, the primary task is to ensure that their lifetime spending needs will be met.
And many business owners assume the size of the deal alone will guarantee there will be more than enough. Often, they’re right; but not always:
They may underestimate their spending needs— especially since former business owners generally find themselves with more free time than they’re used to and a stockpile of assets to draw from.
Even if an owner just wants to maintain spending at his customary rate, his outlays would have to increase with inflation in order to preserve his purchasing power. Long-term, that could have a corrosive effect: At a modest 3% inflation rate, expenditures today would grow by 81% in 20 years. Underestimating the cost of funding their spending needs can cause former business owners to be more aggressive with their other goals than they can actually afford. Proper planning can help ensure that reserves are set aside for all financial needs—spending, family, charity, and so forth.
The first step in that planning process is to quantify the amounts needed for each of those buckets.
Consider, for example, an owner who believes he can clear $20 million after taxes from the sale of his business; he’s planning based on a 20-year horizon, and he wants to be confident that he’ll be able to meet his spending needs. Our wealthforecasting tool can help him by modeling the returns from a variety of asset allocations in
10,000 market scenarios ranging from very good to disastrous. The result is a probability distribution of outcomes that the owner and his team can use as a framework for decision-making.
In Display 2, on the next page, we use the estimates from our model to answer the question, “How much money will the business owner need to reserve from his sale to meet his long-term spending needs
(all growing with inflation)?” Because meeting that particular goal is critical to him, he wants to have a 95% level of confidence: He doesn’t want to have to worry about it. In effect, since he expects his after-tax sale price to be $20 million (in cash), we’re asking if that amount is enough to support his future spending level, and if so, how much will be left over to meet other needs? We consider three different spending levels, and assume that the sale proceeds are invested in a diversified 60/40 stock/ bond mix.1
The results for this owner vary, depending on the extent of his spending:
• With a $300,000 annual outlay (grown with inflation) and a 60/40 mix, we estimate that the owner would have to “reserve” a minimum of $6.3 million of his sale proceeds to be highly confident he will meet his spending needs. If the owner gets his $20 million price tag, he’d have a notable $13.7 million remaining to use for other purposes.
• Even with a $600,000 annual spending hurdle, in our assessment a 60/40 mix would still leave the owner with over $7 million “extra.”
• To assure meeting a $900,000 spending requirement
(with a 95% level of confidence), however, he’d have to reserve virtually all of his sale proceeds. Over the 20-year period in question, assuming all his assets came from his business sale, he’d have only $1 million left to fund all his other needs. If he exceeded that, he’d have to look outside his sale proceeds altogether.
An analysis like this offers dual benefits. It suggests to the seller how much he’ll need to set aside as a “lifestyle fund,” as it were. It also provides critical context for what resources remain for other purposes—to establish a trust or family foundation, for example, or to grow his personal assets to a desired amount over time.2 And as we’ll see, if such determinations are made before the negotiations begin, the deal terms themselves— including the amount of risk and return potential they bring with them—can be tailored to meet the owner’s goals.

3. MATCHING DEAL TERMS TO THE
OWNER’S PERSONAL NEEDS
Many deals are straightforward, with the proceeds all coming in cash on the day the deal closes.
Some offers include a significant amount of stock in the acquiring company, and in those cases other issues may arise: Will the proceeds be fixed at the time the deal closes, or vary based on the performance of the acquiring company’s stock?
Will the stock be subject to a lengthy lockup period (during which time selling is prohibited)?
And whether stock, cash, or both change hands, contingencies may be added to the deal: Some of the proceeds may be payable in installments over time, for example, or include “earn-outs” based on the company’s operating performance.
Such deal-term variants can have material consequences for the owner’s future cash flow. So the deal must be evaluated carefully—and from two different perspectives: the value offered for the business, and the impact of the terms on his personal investment plan. Failure to do so may lead to unnecessary risks or missed opportunities.
Cash or Stock?
An issue often faced by a seller is how to compare cash versus stock offers, and mixtures of the two.3
Not surprisingly, which is more advantageous for a given owner depends on what he’s trying to achieve. A cash deal may be preferable for one owner because of the ironclad safety of the payment—even though ultimately the transaction may be of less value. But another owner with substantial outside assets might favor the riskier stock deal for its higher reward potential.
Consider two competing offers—one for all stock, one for all cash. The stock deal is worth $35 million but comes with an 18-month lockup
(although one-third of the shares are tradable every six months). The cash deal is worth 10% less,
$31.5 million. In both cases, the proceeds when available are diversified into a mix of 60% stocks and 40% bonds. Both deals are expected to close in six months. Which offer is superior?
Our analysis of the value that can accrue to the owner at the expiration of the lockup period can be seen in Display 3. In the median case (the
3 Throughout numbers represented by the dot in the middle of the boxes), we’d expect the all-stock deal to best the all-cash deal by $4 million after taxes.
But it’s important to look at the range of scenarios.
The bottoms of the boxes and below can be regarded as downside cases: outcomes that we’d expect to see only 10% of the time. In this case, we estimate a downside of $23.3 million for the cash deal, compared with $20 million for the stock deal. Despite the higher initial price of the stock offer, cash is more protective. That’s because there’s always a chance that the acquirer’s stock will fall—perhaps meaningfully—before the deal closes or during the lockup period. And so we’re left with a classic trade-off.
Two Owners, Two Offers
But the analysis doesn’t stop here. While there is no single answer as to which deal is better, a clear choice usually emerges when the specific circumstances of an individual seller are closely examined. Consider the case of two owners of separate manufacturing companies, each receiving two offers: one in cash, the other in stock (Display
4). For our purposes, we’ll assume that each owner has received the cash and stock offers described on page 5 ($31.5 million in cash, $35 million in stock), and that each is utilizing the services of a full advisory team. At first, the situations of the two owners appear to be very similar: Each is the sole owner of his or her business; they are the same age, and have analogous family situations.
They both regard 30 years as their investment time horizon, and both plan to sever association with their companies—using $10 million of their proceeds to fund a major new undertaking.
But their differences are just as striking and provide the perspective the team needs to make the proper recommendations. One, whom we’ll call “the philanthropist,” is planning to use the $10 million to fund a charitable family foundation. The other,
“the entrepreneur,” wants to use the same amount to start a new business venture. The philanthropist spends less than the entrepreneur—but has much more in outside assets. These underlying differences trump the similarities; in fact, our analysis suggests that the best choice of deal terms for one (stock for the philanthropist, cash for the entrepreneur) might be a big mistake for the other.
The Philanthropist:
Building a Long-Term Legacy
Over the years, the philanthropist has built up a sizable portfolio for himself and his family from his earnings. With $10 million available to him outside the sale of his business, he already has more than enough to meet his spending needs.
In fact, over his long 30-year investment horizon, there is a 90% probability that he will still have at least $4 million left after taxes, exclusive of the proceeds from the sale. Therefore, with a high degree of confidence he can use all his sale proceeds to fund a charitable family foundation and build a larger legacy for his children. As we’ll see in the next section, this highlights an opportunity for him and his advisors to help meet these goals through the use of certain trust vehicles.
What’s more, because he’s not depending on the deal proceeds for his family’s needs, he’s willing to take on some uncertainty in exchange for a higher return potential.4 And he’s aware that much of the stock can be diversified in a family foundation’s tax-free environment. With all this information in hand, the advising team recommends going with the stock deal.
The Entrepreneur:
Lifestyle Needs Predominate
At first glance, it looks as though the entrepreneur should do the same. The additional value from the stock deal (diversified into 60/40 stocks/bonds) compounds over her 30-year time horizon, offering a median result for her entire portfolio of $53 million, versus $36 million if she’d taken cash (Display 5).
On the flip side, if the markets go poorly, the stock deal could potentially leave her with nothing—versus almost $12 million from the cash deal.
Given the entrepreneur’s circumstances, she must be prepared for a downside event: The new venture she’s interested in carries significant risks, and she has relatively few assets besides what she’ll receive for her business. Therefore, she wants to make sure she extracts enough from the current deal to ensure her lifetime spending needs. At $500,000 annually, growing with inflation, those needs are substantial. If she chooses stock over cash, she may fall short of meeting her financial goals.
Stock Deals: Reducing the Uncertainty
We’ve been assuming so far that these business owners can choose between stock and cash deals.
But that isn’t always the case. What if, for example, the only offer available was for all stock? Would the entrepreneur be required to accept a deal that might not meet her needs? She could reduce her planned investment in the new venture, lower her spending—or wait for higher offers for her business. (Though of course there’s always a danger in waiting for a better deal that might not develop.)
But chances are she wouldn’t be forced to take any of those less desirable measures. Deal terms are often flexible, and she and her advisory team might be able to make adjustments that would likely safeguard her from financial jeopardy.
For example, the entrepreneur’s deal team might try to negotiate one of five commonly used strategies designed to cut stock risk either before the deal closes, during the lockup period, or both:
• “Floor-and-ceiling” on the offer price: Setting a minimum value that the seller will receive regardless of the acquiring company’s stock price prior to closing (say 85% of the $35 million).
A maximum value may also be included to reduce the acquirer’s risk (say 115% of the $35 million). This tactic addresses the risks prior to close, which in this case was assumed to be a six-month period.
• Fixed dollar value of stock: Negotiating a fixed price that the owner will receive at the sale. Though the lockup risk remains, the entrepreneur would be assured of receiving
$35 million in stock at close.
• Receiving a portion in cash: Arranging for the acquirer to pay some of the proceeds in cash.
The entrepreneur’s team might, for instance, negotiate a 20% cash payout. Obviously, this lowers risk—during both the pre-close and lockup periods.
• Hedging after the sale: Negotiating the ability to hedge a portion of the acquired stock posttransaction, which can be beneficial since certain hedging vehicles can reduce lockup risk and preserve some upside participation. For example, the owner may be able to establish a collar
(simultaneously selling a call and buying a put) or enter a prepaid variable forward contract
(similar to a collar but with the added benefit of a large up-front payment to the investor for immediate diversification).5
• Softening the lockup provision: Receiving shares with a lockup period shorter in duration than the initial offer calls for, or applicable to fewer shares. (For the purposes of our case study, we analyze the effect of reducing the number of shares subject to lockup by 50%.)
Display 6 presents our analysis of the downside associated with the all-stock deal for the entrepreneur after 30 years. We show those values for the
“pure-stock” alternative and each of the five riskreducing strategies above. Note that each strategy improves the downside result of the all-stock deal. Just by negotiating the “floor-and-ceiling” approach, the team would increase the owner’s wealth in a downside scenario to almost $3 million
(from zero). Easing the lockup requirements yields the greatest improvement in this example, since it most materially limits the stock-price risk. Further, though not shown in the chart, we wouldn’t expect these tactics to substantially reduce growth potential. In fact, with a couple of these strategies— the 20% cash and 50% lockup alternatives—our forecasts are higher than for the all-stock deal in the median case.6
On the other hand, none of these strategies will necessarily be easy to negotiate, because they may come with costs that the buyer is unwilling to pay. But with the advisory team working together to assess the financial implications of various bargaining chips and to craft an innovative solution, the chances of improving the deal’s risk/reward profile are measurably greater.7
4. ORCHESTRATE TRUST STRATEGIES—AT
THE MOST OPPORTUNE TIME
Matching the terms of a deal to the owner’s goals is just one area where pre-transaction planning can be beneficial. Beyond that, a major liquidity event like the sale of a business creates planning opportunities to build a larger, more tax-efficient legacy and increase philanthropic giving. A variety of trusts can create significant additional value if established prior to—rather than following—a sale. For the sake of illustration, we’ll focus on the two most common beneficiaries of trusts: family and charity.
TRUSTS FOR THE BENEFIT OF FAMILY
A host of vehicles is available for passing assets from one generation to another. Many of them can make sense at any point, but some hold special appeal if they’re part of a business owner’s pretransaction planning. A grantor-retained annuity trust, or GRAT, is a prime example (Display 7).
In a GRAT, an investor (the grantor) contributes assets to a trust and retains a fixed payment each year for the term of the trust, which can be as short as two years. If the grantor survives the term and the investments inside the GRAT perform well enough (success depends on beating an interestrate hurdle tied to Treasury bonds, as defined by the Internal Revenue Code), there will be money left in the trust when the term ends and all the annuities have been paid out. This value can be passed to the grantor’s heirs free of any gift tax. As in all grantor trusts, the grantor remains responsible for any income and capital-gains taxes incurred inside the trust.8
Timing Is Everything
If the GRAT is funded with shares from a closely held business, there is the possibility that substantial additional wealth can be passed to the children. When a minority interest in closely held shares is placed in a GRAT, the shares may be assigned a value that is less than their potential future worth because of their inherent lack of marketability at the time. If the owner later decides to sell the business and receives a price higher than that previously assigned value, the beneficiaries
(typically the children) reap the benefits of the sale premium free of transfer tax. The right amount contributed to a GRAT can go a long way toward meeting a grantor’s legacy goals. And even if the owner decides not to sell the business, or the sale price is lower than anticipated and the GRAT fails to pass any assets to the children, the only costs incurred are the legal fees it took to set it up.
To illustrate the value of establishing a GRAT before a sale, consider an owner who anticipates selling her business at some point in the future.
Her goals call for transferring substantial assets to her children, so her legal team recommends placing a 25% interest in her closely held shares into a GRAT, which we’ll assume has a term of three years. Because the shares lack liquidity and marketability, her advisors value this contribution