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WEALTH INSIGHTS

Personal Finance Strategies for VC & PE Partners

Key takeaways

  • The stages of illiquidity and how to manage them

  • Personal cash management mistakes to avoid

  • Creative debt solutions used by partners

Ann Lucchesi: Welcome, everyone. My name is Ann Lucchesi. I'm thrilled to have so many of you joining us today. We are looking forward to an insightful discussion around Personal Finance Strategies for Venture Capital and Private Equity Investors. It’s clearly a big topic of discussion, given the current macro environment. Let's go into the agenda. 

Over the next hour, we will be delving into the unique characteristics and considerations of managing private wealth, given the complexities of fund structures and liquidity cycles. Through the lens of the investor's unique wealth profile, we will look at the capital call obligations and financing options, balance sheet planning, liquidity management, and tax, as well as estate planning.

As many of you know, our private wealth division was built to support the unique needs of PE and VC investors and the innovation economy as a whole. With the acquisition of SVB by First Citizens Bank, we remain committed and passionate about serving the unique personal needs of the innovation community under the First Citizens Wealth banner. Please submit questions in the Q&A panel and include your email address so we can follow up if we don't get to it live. So, with that as a backdrop, I'd like to now move on to introduce our thought leaders from SVB's Private Bank.

I'm Ann Lucchesi, enterprise relationship manager at SVB Private. I've spent my career working with the innovation economy and have deep expertise in private stock, equity compensation, and balance sheet planning. Next up is Joe Koontz, who leads our tailored lending division. Joe and his team of experts solve the unique needs of our clients through a wide range of custom credit solutions. We also have Tim Couture today, one of our many very seasoned wealth consultants who is focused on providing financial planning tailored to the specific needs of our VC and PE clients. Also joining us today is Lisa Puleo from SVB's Commercial Bank. Lisa is a director on the venture capital relationship management team and will be sharing some insights from the recently published State of the Markets Report. 

Lisa, let's get started.

Lisa Puleo: Thanks, Ann. It's my pleasure to join you all today. I'd like to share, as Ann mentioned, a few key takeaways from our recently published State of the Markets Report that just came out last week. And for those of you that are not familiar, this report is published twice a year, and it includes a deep dive on the key drivers of the technology venture ecosystem, including fundraising and valuations benchmarking, and our 2024 outlook. Also, in this report, we have a spotlight segment on AI. Interestingly, one in four funds closed in 2023 was an AI-focused fund, and one in five companies that raised was an AI company. 

Now, let's get started with the macro. It's likely one of the most important factors at play for venture. As we enter 2024, we're two years into the most substantial downturn of the innovation economies since the dot-com era. We track four key drivers of venture investing, including rates, public market performance, startup formations, and dry powder, to determine the future. And we see several signs of stabilization, suggesting that we're closer to the end than the beginning. 

In the first chart, as everyone likely knows, VC investment is highly correlated to interest rates. And while rates are expected to decline, private market investing has historically been slow to respond. The strongest correlation typically occurs one year after rate cuts. In the next chart, we look at public market performance. And not surprisingly, correlations have only gotten tighter here as private investing has become more popular. And with public markets gaining momentum in the second half of 2023, historical trends would suggest a likely increase in venture capital investment activity later this year. Looking at company formations in the innovation space are clearly trending lower but still significantly higher than the broader U.S. company formation index, and that suggests to us ample opportunity continues—lastly, dry powder. There is no need to share a chart here. It's still massive relative to historic measures. So, while this data suggests no immediate bounce back, we are optimistic that these trends will continue to improve.

Looking forward, the bigger question is, how long will the recovery take? Here, we compare the previous bubbles of the dot-com era and the global financial crisis, and we see a lot of similarities to the dot-com era. Given the correlating elements of rates, technology speculation, and a massive runup of fundraising, we believe the U.S. VC investment is likely to recover more slowly than the relatively quick snapback of the 2008-2009 crisis. And while we have this lower-for-longer perspective, we are optimistic, given very strong tailwinds of disruptive technology within AI, rate cuts, and strength of the public markets, that the recovery will land somewhere in the middle. 

So, what can we expect for 2024? We see relatively bright spots in the early stage, more IPOs, and slightly higher late-stage valuations with challenges that persist in VC fundraising as a whole. With VC fundraising sitting at a six-year low, we're forecasting another down year with weak distributions, LPs at or near their target allocation, and time between funds creeping up, all pointing to consolidation among the largest VCs. Interestingly, in 2023, 53% of the introductions that SVB made to GPs were to buyout funds, compared to just 17% in 2022. At the early stage, we are more optimistic as seed activity remains resilient and valuations are trending up, paving the way for what we expect to be an increase in series A deal activity in the second half of 2024.

In the later stage, while things are improving, we still see valuations down about 35% relative to the peak, suggesting that we're not quite out of the woods yet. Many companies are still facing challenges, having already pulled the levers of RIFs and internal rounds to extend runway. The great valuation overhang still remains here, and we expect to see an elevated number of down rounds at this stage. Lastly, we expect the IPO window will open with at least 15 U.S. VC-backed IPOs in 2024, and certainly, that's exciting. However, we do see down-round IPOs to be the likely norm as valuations continue to reset here.

So, with that as a backdrop, from here, I'd like to pass it along to my colleague, Joe Koontz. As Ann mentioned, he leads our tailored lending division, and he'll share some insights into the investors' wealth profile and some financing solutions unique to PE and VC executives. So, from here, Joe, I'll hand it over to you.

Joe Koontz: Great, thank you, Lisa, for the overview and focus on the macro environment, which segues into the personal impact of these themes, which is what we'll be spending the remaining time reviewing today. And it's clear to everyone here on this call that the personal wealth cycle and milestones of an investor, as we look to the next page here, is unique compared to a traditional professional. Personal commitments need to be made to funds, and capital commitments for venture and private equity investors are unique and complex. Cash flows are often lumpy and unpredictable. And there are really specific considerations around your balance sheet, cash flow management, and estate planning. And through all this, of course, your priority as an investor is a successful portfolio.

All that being said, it could still be very rewarding to spend time on the personal financial strategies that are associated with your personal partnership interests. And so, the panelists collectively spent a lot of time working with investors across these topics. And we'll start by looking at the capital commitment obligation of an investor and the impact personally based on the current environment. And the best way to start doing that is by looking at the standard fund lifecycle. So, you'll be familiar with the J-Curve, but what we're looking at here is the life cycle for two funds, and we're going to look at two different environments. 

So, first here, you'll see the normalized environment where there's a relatively short gap between the investment period ending and when distributions begin. Then, a second fund starts, and the cash outlay to meet commitments is more naturally offset by distributions coming, which makes the investment period, in this instance, more palatable. And you'll see here that net positive cash flows began in years four to five, which is right around the time the second fund's coming online. So, that four-to-five-year period is the horizon where if you don't have liquidity or distributions coming in from prior funds, the cash flow planning is critical, especially if this is your first fund with meaningful economics. 

Moving to the next example, we'll see a set of funds, two funds in a protracted environment where a new fund could be coming online, but there's been a drought of capital or profits being returned from a prior fund. So, net positive cash flows don't kick in here until about year seven, which can clearly create stress in cash flows and require investors to think about financing strategies, which we'll talk through. So, if you're a seasoned partner, you'll likely have realized gains and successes from prior funds that could be utilized, but oftentimes, earlier partners will face a bigger challenge in this type of protracted environment. 

So, I'm going to send it to Ann for a quick poll question at this point.

Ann Lucchesi: Let's just take a little minute here. We're going to put on a simple poll question, which is true or false. Cap calls must be met through personal liquidity. And by this, we mean you have to have cash set aside in the account ready to go for when that cap call occurs. 

And while all of you are answering the question, let's consider for a moment the current environment and its implication on returns. Did you know that 2023 represented the least amount of exits for PE in a decade according to PitchBook? This can have deep implications to the return rates that some funds need before they hit their entitled carried interest portion. 
Let's see if we can take a look at the responses here. It looks like most of you know that this is false, that 13% think that it is true, and 87% think it is false. 

Joe, I'm going to hand it back to you to answer the question.

Joe Koontz: Well, it seems like everybody practically knows because the answer is false. And there is a variety of ways that capital calls could be met, and we're going to be walking through those. 

First, it's important to note, as we dig into this topic, that you need to identify the type of capital commitment you have, whether or not this is a mandatory participation as part of a partnership or GP or whether you're making a voluntary or co-invest commitment in addition to a GP commitment. So, the most common ways to meet commitments are personal liquidity, which we discussed by using cash or liquidating assets; second is support from a firm-level mechanism; and finally, financing solutions. And so, given that the liquidity's pretty straightforward, we're going to focus on the final two. 

So, first is support through the firm. And as we go through these, a lot of people are probably using these strategies. It's important to keep in mind that tax proposals and regulations are constantly evolving, and a firm and a CPA are likely to have a view across these strategies. It definitely will vary by firm. So, it's worth talking to the fund manager and finance team to understand what's available to you. 

Starting from the top here, though, management fee offset; this is where management fees paid are reduced by an amount of board compensation from portfolio companies. Next is a cashless contribution, where a management fee or a salary can be reduced by up to the full 100% of a capital contribution through any given period. And in exchange, you have access to the first gains in the fund. Next is a management fee waiver. Very similar to the cashless contribution, but GPs are waiving a predetermined percentage of their management fee at the onset of the fund similarly for priority gains in the fund. And finally, a loan taken at the firm level, and this is usually a GP entity or a management company that takes a bank loan directly to support their partners in financing their commitment. 

Across this, we really encourage people to understand what, if any, of these options are available by the firm at any stage in your wealth cycle. Because they can be absolutely great tools to help meet your capital commitments, whether they're modest or outsized. So, next we're going to be looking at financing options. And this is going to be shown through a continuum of accessibility; the more liquid you become personally, the more access you'll have to these solutions. 

So, starting at the bottom of the slide, which is the most accessible, is an intra-family loan. And this is taking a loan from a family member, usually at the minimum applicable Fed rate. And when using this type of loan for a capital commitment, we've seen instances where payments for interest or principal can be delayed. This solution is one where you usually have limited options and haven't gotten to the stage of significant wealth or liquidity creation. Similar to an intra-family loan, it could be used in a different way where you're lending to yourself within your estate. And we'll be taking a closer look at the estate planning strategies later in the hour. We'll address that specifically.

Next is real estate financing. And regardless of where you're at in your wealth life cycle, so long as you own real estate, it's a really good tool to access equity and utilize an interest tracing strategy. And that's a topic we'll address later. But this is strategic leverage that could be used regardless of where you are in a fund life, and you can potentially lock in a fixed rate through a cash-out mortgage if rates are attractive or use this like a line of credit through a home equity line where you only need to draw when necessary. 

Now getting into the more bespoke lending, which is less common but familiar to this group, partner financing. And when we reference this, it's addressing a loan where the purpose is exclusively to actually finance a capital commitment.

If you or your firm have access, it's a great opportunity to use strategic leverage on a loan where the draw period of the loan matches the investment period of a fund, followed by repayment in later years when you're seeing distributions. This is a tool that's used commonly both by early partners or seasoned GPs, regardless of the size of your commitment. And oftentimes, access to this type of financing will impact the level of commitment that you decide you want to make to your fund. So, it's important as you start planning for your fund commitment size to consider this option early and make sure that it's put in place either prior to or about the time the fund is coming online. 

Next is custom lending. I usually call this a private bank loan, which is reserved for the more robust or diverse balance sheets where there's usually the creation of wealth through fund interest, or in some instances, you've already had liquidity events or both. And this is a personal recourse loan where a bank will evaluate all of your assets and cash flow. So, if this type of situation fits your profile, it's best to speak with an advisor to learn about your options.

At the top of the slide, we have a securities back loan, and most banks do this. And so, while it's noted as less accessible, it's because it's liquidity dependent, and there can be some customization. This is really just a loan secured by a portfolio or a single stock position. So, for newer partners, if you've accumulated wealth prior to becoming a fund investor, it's a great tool to leverage to meet capital commitments to a first or second fund. And for seasoned partners who've amassed wealth and successes through prior funds, it's a smart way to really raise capital, avoid liquidating a portfolio, having the potential tax consequence, and just provides a lot of flexibility and cost effectiveness. Finally, for investors who are on a board and have a single stock distributed to them and want to hold that stock or are an insider for the company, leveraging that concentrated position is a form of a custom securities back loan and something that banks will do.

So, after having some of that backdrop on the different funding strategies, I do want to move into looking at some numbers just around broader performance, talking both historical and forward looking. So, this slide here shows IRR by vintage across a number of different strategies. And so, we'll see prior to 2021, by and large, we're looking at historical highs for returns. And this was coupled with a really low rate environment, you know, in the 3% range, which obviously made for a great environment and opportunity to leverage to create a rate arbitrage. People's successes were becoming a lot higher with utilizing loans and realizing the IRR that they had in this time. But as we move to the next slide, we'll see a different picture, which is forward-looking.

This graph actually reflects IRR starting in Q3 2023, and it projects out one year, three years, and beyond. What we see is a relatively bleak outlook in the short term, nothing nobody here isn't familiar with, but a lot of optimism in the medium to long term. In a unique way, this is coupled with uncertainty around a rate environment, which is nearly double what borrowing rates were compared to the last chart that we looked at. So, when you're thinking about taking on leverage with these expected outcomes and the effect of compounding interest of taking a high single-digit rate loan, all that should be taken into consideration when you're evaluating what type of funding is best for you.

So, let’s move to the next slide here and really drill down into a lot of the things that we talked about. These are the key considerations that will help you make decisions, specifically around leverage strategies, starting with how long do you expect to carry debt, which I just mentioned. The question is, what is the impact of compounding interest as it relates to your outlook and your investment strategy regarding the expected returns? And in what period are you carrying that leverage in the current rate environment? And finally, what's your household's view on leverage? And that's a more personal approach, which will vary, but it definitely calculates into the equation. 

Taking time to evaluate all of this and discuss with your advisor should help drive a decision you're comfortable with regarding financing and funding your capital commitments. 

I'm going to bring back Ann Lucchesi, who will walk us through the importance of balance sheet planning and kick off with another poll question. 

Ann Lucchesi: Thank you, Joe. Time for another quick true-false question. Are money market accounts, known as MMAs, the same as money market funds, commonly called MMF accounts? 

While you are taking a moment to answer this question, let's think a little bit about how important cash management has been in the last couple of years while we have seen an inverted yield curve. Did you know that in 2023, we saw the deepest inversion in the yield curve since 1981? And the real question is, does this signal a recession looming, or will long-term rates finally begin to normalize? Managing your cash properly through this time could significantly enhance your overall portfolio returns.

Let's see if we can take a look at the results of this. It looks to me like about 10% of you think that it's true and 90% false, and you would be right. These are two very different instruments, and it's important to understand the difference. 

A money market account is typically a bank account, and it pays a higher rate of return than a typical deposit account would. However, it is subject to FDIC maximum insurance levels and has no tax advantage. On the other hand, a money market fund is considered to be a mutual fund, typically found on a brokerage platform, and it's invested in highly liquid near-term investments. It is not subject to FDIC insurance as the risk resides in the underlying instruments that it's invested in. Some money market funds can also have tax advantages depending on what they're invested in.

Let’s move on to the next slide, where we're going to begin to talk a bit about balance sheet planning and what that means. We had a little discussion there about cash management, which is just a piece of this overall balance sheet planning. One of the things that we think about in terms of VC and PE partners that is really important when you're thinking about getting advice, and planning is to have a broader approach to this. As much as your balance sheet is in illiquid investments, and often you'll choose this barbell approach, meaning lots of cash, lots of illiquid investments with very little in between. And so, you really want to make sure you’re getting the right advice in that context.

Cash flow planning can be paramount for most partners as they think through future commitments to their funds, not just one fund, but maybe multiple funds and maybe multiple side investments. That being said, in a lot of the various planning fields, you’re still going to do all of the normal things. You're still going to have retirement planning, trust planning, you might have business banking, etc. We are not going to try to boil the ocean today on everything, but we're going to touch on three things we think are top of mind for partners: cash management and tax strategies, and then we're going to wrap up with a section on estate planning considerations. 

We’re going to start just with tax efficiency on interest tracing. A lot of people think that in terms of being able to write interest off, you're able to write off interest from your mortgage, which is typically capped at about $750,000. In fact, there are other strategies that could allow you to write off other interests. The most important component for you to be able to write off interest when you're thinking about the efficiency of taxes in this is, where do those funds get used? And so, when we think about interest tracing, we are thinking about the use of funds as going into an investment, and we are tightly tying that borrowing piece to the investment piece.

So, it doesn't matter so much how you borrowed; it might be personal interest, say, a credit card. I hope you don't do that. That would be a high interest rate, but a credit card would work as long as it's tied directly to your investment. It could be through the use of a HELOC, or it could be through any sort of loan that’s just tied directly to interments. Once you have done that, the IRS allows you to essentially write off that interest from that loan across your net investment income on your portfolio. Now, critical to all of this is that you engage with an accountant, and they're going to have a point of view on how this is done. A little later on, we’ll talk about an example where people have done this using a home.

Let's talk quickly about cash management. When we think about cash management, we are typically thinking about three buckets. We are thinking about daily operating, goals-based cash, and then strategic cash. And we've laid this out across the J-curve, although, as we all know, this isn't kind of a perfect representation. But daily cash management is something that all of us have to worry about. It's paying our bills. It's all those bills we have day by day, typically met through bank accounts, checking, and savings accounts. And so, certainly, even early partners that would have no real liquidity to their name have enough to pay their day-to-day accounts and have to think about that daily cash management.

Now, as you begin to get distributions, you would move into this next phase, which we think about as goals-based cash. Typically, in this space, we're focusing on the 12- to 24-month timeframe. So, we're thinking about, "Do I need to set aside some cash for taxes? Am I trying to buy a home in the next 24 months, and so I need to save for a down payment?" You're going to look at the buckets on this and then pick the right type of vehicle to get you an optimum return with the proper amount of risk. So, you might find in this space things like money market funds, CDs, insured cash sweep, or short-term treasuries.

Finally, this final bucket is what we think of as strategic cash. These are funds that are a component of a broader strategy and are not necessarily needed in the near term. So, these funds are likely to take on a little higher risk; they're going to have slightly less liquidity, but you're hopefully going to get much more long-term on the return piece. So, you might think in this space that this could be a separately managed account like a Muni bond fund of sorts. All sorts of things will fall into this, and they all will have their risks and rewards. You'll want to make sure you're talking to an advisor as you go through this. Every partner should have a cash management strategy as they begin to get distributions because cash plays such an important and vital role in their overall balance sheet. 

I find that at the top of every partner's mind is taxes. And it doesn't even matter which state you are in, although if you are in certain states, it's more important than others. Reducing your taxes is a very important thing. So, you should map out a tax strategy. On this slide here, we're going to talk through some of these things that we think are important. Just know that this is not an all-inclusive list; there are a lot of things in it. In the early days, even before you have much liquidity, it's really important to begin to understand the different types of taxable income and how you can optimize. So, we have ordinary income, and there's a tax rate on that. There are short-term capital gains and long-term capital gains. And then one of the biggest benefits of all that many of you can take advantage of is the qualified small business stock exclusion (QSBS). We think everybody needs to understand that before they start receiving their distributions, QSBS can be one of the biggest advantages within the innovation economy. You want to find the right tax advisor who's going to help you make the decisions across the balance sheet as you're doing this.

Because you are a partner in these firms, you are likely a high-income earner, and therefore, you are in a high-income tax bracket. Therefore, even from the early stages, you should be thinking about how you can maximize retirement deductions, and it should be a priority across your career because different things come along, and again, you should work with your accountant. As you get deeper into being a partner, you may sit on boards, and you may have an opportunity to do a SEP IRA and things that can actually really maximize that amount you're deducting from the income.

As your wealth grows, you should consider the impact of bunching your itemized deductions. Hopefully, again, you have an accountant helping you, but we often find people as they're doing their own taxes in the early years, and then they begin to move to a CPA; they don't think about how important bunching itemized deductions in a particular year can be. We encourage people to think about utilizing the backdoor Roth IRA from a very simple point of view: You're contributing after-tax dollars every year into a traditional IRA and doing a conversion into a Roth so that it can then grow tax-free.

One of the great things about a Roth is you will never have to take a required minimum distribution, and you can let that money grow until your death unless you need it. We also see the use of self-directed IRAs where you can put alternative assets, and this allows you to take an investment that might have an outsized return and put it into a tax-deferred or tax-free vehicle of either an IRA or a Roth IRA. Again, these decisions need to be made in conjunction with your CPA.

And then, finally, as you continue to grow your wealth, there are things that you should automatically think about. So, for partners starting to get real wealth and thinking about their estate tax and what they can get out of their estate, they should think about doing their annual gifting exemptions. Currently, that's $18,000 per person per year. We encourage people to utilize donor-advised funds, particularly in those high-income years.

For those of you who don't know what that is, it is a fund that you can contribute to; you take your deduction in the year of contribution so you can make a larger contribution into it, get the charitable deduction, and then you can gift out over time to your philanthropic interests. It is very efficient for anybody who has income streams that are a little bit lumpy. And then finally, one of the overlooked planning ideas is the idea of using debt for tax efficiencies. So, we touched on this idea of interest tracing a little earlier. We're going to go a little deeper into that, but that would be a form of optimizing debt for tax efficiencies. 

Here, we're going to go a little deeper into that concept of interest tracing, and in this case, we're going to have someone do this through the use of their mortgage. So, we're going to assume here that we have someone who owns a $5 million home, and they have a mortgage on that of $2 million. And they're just beginning to receive distributions. They receive a distribution for $1.5 million that they really would love to put into a diversified portfolio. So, to optimize around this, one of the things they can do is they might take $1.25 million of this and pay their mortgage down to the $750,000 mark. And this is to preserve that mortgage deduction that they're already taking.

They will then wait what they call a cure time, and this is set by every CPA, but it's an appropriate period of time before you are going to go in and do a cash-out refinance. Oftentimes, we see that somewhere around 30 to 60 days. Again, this is something your CPA has to opine on. At the end of that time period, you do a cash-out refinance, and you bring your mortgage back to $2 million; you now take the $1.25 million that you received in that cash-out refinance, and you're going to wire that directly into an investment account that has a diversified portfolio. 

So, what does this leave you with? It leaves you with right where you started, the $5 million home, owing $2 million on it. You still have a quarter of a million in cash that you kept, and you now have a $1.25 million diversified portfolio. The great thing now is that all of that interest off of that mortgage, at least the $750,000 for the qualified residential piece, and then the $1.25 million, all of that interest can now be deducted. And that deduction is across all net investment income across your portfolio. So, interest, dividends, anything that becomes in the net investment income, and this will reduce your taxes on that portion.

Now, one of the key things here is that the investment that you go into cannot be tax-exempt bonds. So, while it might seem clever to be able to take that money out and put it all into Munis, that is one of the things the IRS doesn't allow. The key to this is to engage with your accountant early on, make sure they're on board, make sure they're giving you advice around this, and then you always want to make sure you have it really clean. Even for people who already have investments with us, we typically will set this aside as a separate account that is being managed so that we have a really clear line of sight between the investment and the interest that's being borrowed.

From here, we're going to move into talking about estate planning. And we are going to start with another poll question. True or false, you can gift carried interest into an irrevocable trust. 

And while you are thinking about this, for all of you in California, did you know that there has been a big tax law change this year regarding incomplete non-grant or trusts that were created outside of California? These have been used oftentimes in the past to allow you to earn interest on those trusts and not pay California tax. Those no longer have the same benefit this year, and now that tax is going to come back and will have to go onto the grantor's California tax returns. So, it’s really important, if you have it, the name is called an ING or ING trust, that you engage with your CPA to understand how it's going to affect you and most certainly will affect future planning. 

Let's take a look at the results. It looks like about 89% of you say it is true that you can gift, and 11% say that's not true. 

I am now going to hand it over to Tim Couture, one of our experienced wealth consultants, to take this question on and explain how it can or cannot be done and the parameters around it. 

Tim Couture: Thanks, Ann. Good afternoon, everyone. So, most of you answered the answer correctly. However, there's a little caveat when thinking about gifting carried interest. And so, before we talk about the mechanics of it when thinking about making gifts, the irrevocable trust, you want to consider highly appreciating assets. For gift tax purposes, the value of the gift is what is considered at the time of the transfer. So, when you're making that gift, it's important to hire an independent appraisal to get that value and make sure that your CPA is aligned with that valuation as well.

After the transfer, all future appreciation grows outside your taxable state within the trust. Obviously, one of the biggest assets that is appreciating for most of your general partners out there today is carried interest early in the fund's life cycle. You're able to gift carried interest. However, Congress enacted a rule in the early 1990s, Section 2701. We don't need to go through that today to bore you with that. But basically, it slightly restricts the ability to gift only carried interest. To avoid running into issues with this rule, you gift what's known as vertical slice.

As you can see from the slide here, you need to give proportionately the carried interest as well as your ownership interest in the fund. And so, for instance, if you want to gift, for example, 25% of your carried interest in a fund, you're also required to give 25% of your ownership interest in that fund as well. So, you're proportionately reducing each class of ownership in there. When Joe was talking about the cash management slide as far as the intrafamily loans, and as Lisa mentioned, as far as the extending of longer time periods of waiting for liquidity to happen within these funds, the intrafamily loans, if you've set up these trusts prior, you may have been using these intrafamily loans to help continue to fund the capital commitments within those trusts. The reason is that when you transfer your commitment or a portion of your commitment to these trusts, that trust now owns the liability or the capital commitments for that percentage. 

So, the state tax exclusion has steadily increased over the past few years. For 2024, the current estate tax exemption is about $13.6 million. The way that legislation is today, that estate tax exemption will continue to increase based on inflation, but it set the sunset at the end of 2025, with most people thinking that it's going to be cut roughly in half. For individuals exceeding or projected to exceed in the coming future, this presents a tremendous opportunity to start thinking about gifting considerations prior to estate tax laws changing. 

Now that we've talked about gift and carried interest, where the current estate tax exemption is today, we just want to throw out a type of vehicle that we've employed with the law clients here, and that's known as a spousal lifetime access trust, otherwise known as a SLAT. A SLAT is an irrevocable trust that is established by you, the donor, meaning the person gifting the assets is alive. The trust is established for the benefit of your spouse and the kids, or if you have children, are typically named as contingent beneficiaries.

We've seen SLATs used as a successful way to remove assets outside of the family's taxable state while not completely relinquishing control or access to the funds entirely. That's in conjunction with if we were talking about a dynasty trust, where typically, the kids are the main beneficiaries. If you're giving assets to the kids outright, there's not really any access that you or your spouse will be able to tap into those funds necessarily. When thinking about irrevocable trust from a high level, to draw back a little bit, there are two ways that these types of irrevocable trust are structured for income tax purposes. They're either known as a grantor trust or a non-grantor trust.

And really, the biggest difference between the two is grantor trust means that the income generated from the trust flows onto the grantor or the creator's tax return while you're still alive. For non-grantor trusts, that means it is its own tax filing entity. Also, when you're thinking about non-grantor trust, typically wherever the trustee is located, that's the state that governs the trust. So, it's important if, for instance, you're living in Texas where there's not any income tax and you have the trustee living in California for these non-grantor trusts; that may not make sense just because you're going to suddenly bring those assets into a higher income tax state.

There are pros and cons to both. Ann mentioned the QSBS as well. So, it's really important to, when we're talking about aligning yourself with a team, to make sure that you have your CPA state planning attorney that really understands your ecosystem specifically. We see a lot of times that clients have the family CPA, and that's great up until you start to get these liquidity events, and they really aren't able to be tax efficient with you. Joe mentioned leverage, being able to think about how to achieve and maximize after-tax returns with the use of leverage or even these gift tax plannings, and making sure that all your team members are really rowing in the same direction so that everyone's aligned with the strategy.

Also, before you start going too far down the road, as far as suddenly setting up these trusts or trying to figure out gifting strategies, it's important to read the operating agreement. We've seen a few times where the operating agreement can be restrictive as far as who you can gift and who you can transfer the carried interest to. So, it's important to read that first before going too far down the gifting road. Also, two other additional high-level considerations that we want to give to before I hand it back to Ann is family planning before large liquidity events is key, not only from an income tax perspective but a legacy asset protection perspective as well.

And then lastly, if you plan on moving residencies between now and liquidity events, understand the requirements in order to claim residency in the new home state that you're going to be residing in. 

Ann Lucchesi: Great, thanks so much, Tim. We are going to move into one last poll question. This is kind of a fun one just to see what everybody out there thinks. The question is, when do you think the IPO window opens up: the first half of 2024, the second half of 2024, or the first half of 2025? 

So, we're going to be opening this up for Q&A in a moment, so I hope you've put your questions in the box. We know that many of you have submitted questions when you registered with us, and so if we haven't covered those within the session today, you can expect someone will reach out and cover those with you one-on-one. We welcome any other questions at any point along the way.

Let's go ahead now and take a look at the results. It looks like nobody's too optimistic about obviously the first half of 2024, but I see 44% of you think the second half of 2024 and 41% in the first half of 2025. I think we're all hoping a little sooner than later, but we'll all have to take our time and see what happens. 

Let’s move on to Q&A. We've had a few questions in the box. 

I am actually going to start off by asking Tim a question that comes up a lot that he touched on, basically, which is just this idea of moving from a high-tax state into a lower-tax state, which comes up frequently within the PE/VC world.

Do you have some advice around the steps to make this happen so that they can actually take that lower tax bracket? And then, is there a certain number of days that you have to be in the state when you go to declare this as your state of residence?

Tim Koontz: Typically, the easiest one to check off is if you spend the majority of your time in that state. So, if you're in between California and Nevada, call it, if you're spending over 183 days in Nevada, that checks that initial checkbox. But a lot of us are traveling around whether for work or leisure. So, you may spend 100 days in Nevada, 50 days in California, and then spread out throughout the U.S. or even internationally. So, there are a few other factors to consider. Where are your bills being mailed to if you are getting paper delivery? Where's your driver's license? Where are the kids, if you have any, living, and what school are they going to? Are they resigning in Nevada with you?

There are a lot of those factors to consider when determining if your home base is where most of your life is lived. And so, we've seen cases where the California Franchise Tax Board comes out, and they even requested phone records to make sure that you're claiming the residency where you are and making sure that you're, the number of days you're saying you're in Nevada or Texas actually is true. That's on the far extreme side, but there are a few different parameters to make sure that you're claiming residency in the state that you feel should be your home state.

Ann Lucchesi: I'm going to follow on there that just because I'm in California and hear this frequently is, I was told once, the other thing to remember is the people that are looking at these changes at the state level are not people that are making millions of dollars. So, if you move from a home that's worth $10 million in California and you move to a $450,000 apartment in Wyoming, you can guarantee it'll get flagged no matter what else you do because they're thinking about is this really likely to have happened for this individual? So, think about all these things and consult an advisor when you go into that.

Joe, I have a question for you. And here's the question: I run my own fund, and we are currently looking for a first office. I also invest in commercial real estate off my own balance sheet. I'm considering possibly buying a small SF commercial building and becoming my funds landlord. Good idea or bad idea? What should I watch for?

Joe Koontz: It's a good question, and it's something I think if you're going to be the sole tenant and have control over that, and you can use it as the actual management company or the GP entity owning that building, and it is titled to them, it could be a really smart move. We've seen some very prominent venture firms, particularly in the Bay Area, use that strategy frequently, and it turns out to be a very smart tax decision for them. So, while I have to be careful what tax advice I give here, it's definitely something that's worth evaluating, and you should also consider what type of leverage you can use to improve your returns as you're evaluating that through a commercial real estate loan. So, I think it's situational, but we've definitely seen that work very well for people, especially if they're early on in the fund formation mode.

Ann Lucchesi: Great. Thank you, Joe. All right, I'm going to put another one back into Tim's hands. How do you think about or how should a partner think about commitments when making allocation decisions for cash? So, when leveraging fund commitments, are you investing the dollars you save by borrowing into something else, or are you keeping it as a reserve? Or how should someone think about this as a whole?

Tim Couture: Yeah. So, the way that we help individuals or families think about this is really we start with a basic cashflow planning analysis because everyone has different nuances in life, whether it's trying to plan for a first or second house down payment, college tuition, or even family support and/or other outside investment interest. So, it's really starting with that cash flow planning and trying to get that waterfall schedule, which we know has constantly been changing, and there’s no crystal ball. It's really starting there with the basics, understanding what your personal cash flow needs are to help decide when to make the decision to move into cash from cash to investments or being able to efficiently use leverage to help bridge gaps, too.

Ann Lucchesi: Great. Thank you. All right, I've got one. I'm going to put it in your lap, Joe. And I'm probably going to follow on the backside of this, which is, have you seen GPs putting carry into their Roth IRA?

Joe Koontz: Yes, absolutely. It's pretty common with some popular general partners, and it is something we've seen. I won't speak to all the estate planning benefits to it, but it's definitely common, usually for folks who are post-wealth creation where they're seasoned general partners.

Ann Lucchesi: And some of the things when they go to do this, at least from my point of view, is one of the big things is fund documents have to allow for some of these things because you're actually essentially purchasing into that IRA. So, that's going to be done in a self-directed IRA, which you mentioned earlier. It can be a terrific way over the long term to have growth outside of, not outside of, your state, but certainly outside of taxes. If it's in a Roth IRA, it will grow tax-free. The one thing that I always caution people to make sure they're thinking about when they do these kinds of things is make sure this is not cash that you're going to need to have at some future point in time because once you put it into a retirement vehicle, there's a lot of penalties for taking that back out. So, be very thoughtful when you're making these decisions. Make sure you're engaging with the right attorneys and CPA to make sure you're following all the proper laws on that, but it can be a really big benefit downstream. 

I'm going to ask Tim another question and see where this goes, which is, under the interest tracing approach, when you take the proceeds, and you put it into, let's just say, a diversified account, does it have to stay there forever, or can I move it to another investment? What are the rules around that?

Tim Couture: I’ll answer as best I can, but as you alluded to, Ann, earlier in the presentation, each CPA that we've come across has a slightly different stance as far as how to take advantage of the interest tracing or the interest deduction rules there. So, typically, the way we've seen it from a conservative standpoint is the assets stay within that account. Yes, it could be used, but you're losing the power of those assets that are generating the investment interest to offset the liability that you have. That's kind of how I'll phrase it right there, just because I know that we're not CPAs, and each CPA is going to take a different stance on that.

Ann Lucchesi: Yeah. And I think that's important to think is that at least in my time talking to multiple CPAs, I've heard all different sorts of ways that they look at this. And so, it's really important that you're letting them help drive the boat on this one because they're the ones who are going to have to sign off on that return in the end. 

All right. Back to Joe for another question. Can personal GP commit loans to be undertaken after a fund has started calling capital?

Joe Koontz: It is possible. Usually, those are going to be limited to capital calls that are remaining in the fund. In some instances, there could be the opportunity for what's known as a lookback, where you can look back into capital paid into the ground prior to the loan being put in place, but that's not always the case. So, I'd urge everybody, just as you're looking for that particular type of loan, to have that put in place from the outset of a fund so you can use it beginning with the first capital calls that are made. It is possible; it's just not guaranteed. So, I'd err on the side of caution.

Ann Lucchesi: Thank you. I've got another one that I'm going to follow up with you on, Joe; we certainly have heard this question before. So, this won't be new. What are some of the best or most creative solutions for accessing liquidity for large, diversified pools of privately held assets? 

And so, we could think about that as maybe it could be your fund's interest, it could be angel investments, etc. And I'm going to caveat this as you go into that, Joe, by saying that the marketplace has shifted quite a bit in the last couple of years, and so it doesn't look the same way it did even a year ago; I don't think.

Joe Koontz: Yeah, that's a good kickoff, Ann. I'd say, you know, there was a lot of private lending against individual pre-IPO stock over the last several years. With limited secondary transactions and the uncertainty around the IPO market, there's a lot less of that, especially with traditional banks. 

What I will say to address that question, though, is if you do have diversification on your balance sheet and as part of that, you have single concentrated positions, but you also have partnership interests and funds, and you've got a diverse balance sheet, I would say this falls into that category of a private bank loan, which I touched on a little bit earlier. It is something that banks will do to customize. So, I would urge you, if you do have that type of profile, to reach out to your advisor and have that conversation to understand what the most efficient form of leverage is and what options you have available to you. Assuming that there are enough assets and revenue streams on your balance sheet, there very likely could be a solution there.

Ann Lucchesi: Great. Thank you for that. And I would just say, you know, this is something that we often find, Joe; as you know, over time, the marketplace shifts and ebbs and flows, and people have different parameters and capacity for lending on different things. But typically, any of these types of pools of privately held assets were expensive before rates climbed, and today, they're very expensive if you can get a loan. So, it's a changing environment at all times. 

Another question for you, Joe. Can you discuss personal guarantee versus management company guarantee?

Joe Koontz: So, when I was talking about the different financing solutions, most of those are going to be full personal recourse to you individually. So, regardless of what's being pledged as collateral, you, individually, as a borrower, are also going to be on the hook as a personal guarantor. When we talk about a management company guarantee, that is a solution similar to that partner financing I discussed where a firm is willing to actually guarantee the loan from a credit standpoint, but an individual will still be a borrower on the loan. So, still personal recourse, but there's an element of a management company guarantee that usually allows a program to be made available more broadly for a firm or help with partners who might not have the creditworthiness to be able to access a loan on their own.

There's a separate type of GP loan, which I'll mention, and that's when the GP entity or management company actually takes a loan directly. So, there's no personal recourse involved; it's a corporate loan, but the proceeds could potentially be used to meet a GP commitment, which inevitably is going to help the underlying partners who are associated with that commitment. 

So, those are three different flavors I kind of laid out there, which is just a standard loan that you're taking yourself as personal recourse. It's the loan that is to you as a borrower, but it's supported by a management company guarantee. And then, finally, it's a corporate loan that's taken directly by the firm or the fund in order to support the underlying GP commitment that ultimately supports the partners of the fund.

Ann Lucchesi: Great, thank you for that, Joe. And we're coming up on our time. I'm going to put one more question out into Tim's world, which is simply because we know that the estate law may change, and there's going to be a lot of white papers written over the next year about this. What should people be thinking? How fast should they be reacting to this? 

I think the last time that the estate law was going to change, I found a lot of people were rushing at the last minute to get things done, and then, in fact, it didn't matter anyway. Just would love to get some thoughts from you on that.

Tim Couture: I would phrase it as don't rush to do it. If you've already been considering doing it, then that's the conversation. I don't think because the tax law is changing, it should press you to make a change or consider gifting strategies. That's typically how we start by saying, are you even considering relinquishing control of any of these assets? Or who are you trying to benefit? Because when we're talking about setting up an irrevocable trust, there is going to be some relinquishing of ownership there. You're not going to have full access to that. Who do you want to benefit from that?

And so, if we already are working with families that are already considering that, great, let's continue the conversation. It just means that we know that there's a potential finish line that we need to wrap the planning strategies up with. However, if someone coming in is saying, "I have $15 million on my balance sheet; I need to get down below $7 million," that should not be a driver to suddenly set trust and gifting to people. It's more or less based on your own personal goals and wishes. You mentioned the donor-advised fund; someone else, I believe, in the comment section, mentioned a charitable remainder trust.

So, it's really trying to align your goals and who you want to benefit. Is it charitable inclinations that you have? Then, there are a lot of different strategies to go down that road. The same thing happens if you're trying to benefit not just your heirs but other future generations, too. So, there's a lot of different structures there. It's the same thing that you mentioned with the INGs or the DINGs and the NINGs. Each state has its own estate tax laws, too. So, on top of trying to figure out what's going on at the federal level, you also need to be cautious as far as what's going on at the state level.

Ann Lucchesi: Right. Well, thank you for that. We're going to wrap it up. We're at the top of the hour. You'll be receiving the recording and the slides over the next couple of days. Please feel free to share it. 

To discuss your unique situation, please feel free to contact your private bank, private wealth advisor, or relationship manager or reach out to one of us. And we do have that State of the Markets Report available if anybody is interested in getting that. Lots of great information there. Thanks again. I appreciate everyone joining.