Planning for Executives - 8 Value, risks, and tax implications of utilizing prepaid variable forwards in concentrated stock situations Flashcards
What is a prepaid variable forward
A strategy used by stockholders to cash in some or all of their shares while deferring the taxes owed on the capital gains.
-Monetizes concentrated position without selling the shares and
recognizing taxes
-Retains appreciation up to an upper limit (cap) as defined by the client
-Provides a measure of protection against a decline in stock below a
lower limit (floor price)
When would you use a prepaid variable forward
If you were an investor who own a large number of shares in a single company and want to raise cash while postponing taxes.
-some executives who are granted stock options are prohibited from selling them for a certain period of time
-large stock transaction by a company insider at any time makes investors nervous.
What are the advantages of an prepaid variable forward?
-allows a large shareholder to cash in while postponing taxes due to capital gains.
-Significant liquidity generated
upfront
-Tax recognition deferred until
maturity
-Provides downside protection for
stock price
-Investor retains ownership, including
dividends, voting rights until maturity
date
What are the disadvantages of a prepaid variable forward?
-Ceiling on upside exposure; Investor
does not participate in any
appreciation of the stock above the
cap
-Shares pledged for the interim period
What are the tax implications of a prepaid variable forward?
-The use of a variable prepaid forward contract allows that person to sell the stock to a brokerage company.
-The investor is immediately paid between 75% and 90% of the current value of the stock, but the transaction is not finalized.
-Until it is finalized, the taxes on the capital gains are not due.
The number of shares to be delivered will depend on the stock’s
______ at the time of delivery
price
Example of diversification with a prepaid variable forward
