In the third installment of the 3 Pillars Podcast, Peter Harper, our Managing Director and CEO discusses with a special guest the value of tax planning and consideration of risks prior to a liquidity event.

Peter and special guest Steve Martini, discuss how optimizing your taxes, risk management, and careful planning of a liquidity event can perpetuate a successful family office when you have a trusted advisor.

To watch or listen to the full podcast, click the link below or just press play:

https://asenaadvisors.podbean.com/e/tax-optimizing-taxes-can-make-you-wealthier-and-reduce-your-risks/?token=149f0e6aae8be818f9287786fbecd1e3

TL;DR

Peter Harper: [00:00:22] Steve Martini, thank you for joining me here today on the Three Pillars podcast. Today, I want to talk about taxes as part of the value operational pillars. So for folks that are dialing in for the first time, the podcast is focused around the pillars that we think are essential to the idea of a multi-family office or as Stephen and I were just talking about a multi-advisor family office, which we think is probably more apt description for a lot of folks. And within that category: How people should be thinking about the risk weighting when it comes to their approach to sort of tax planning and taxes in general. So Steve, do you mind giving everyone a bit of an introduction about yourself and your business?

Steve Martini: [00:01:31] Yeah, sure. Martini Akpovi Partners is a 50 person Encino, California based accounting firm, full-service firm serving people have already had liquidity events, small middle market companies, trusts in the state. We also have an M&A practice. So some of the issues you’re raising are a very common occurrence for us because we’ve gone through clients with 5 million dollar liquidity events. We’ve gone through clients with 100 million dollar plus liquidity events. Most are in the 5 to 50 million dollar size. And so this is a common discussion that we’re having with our clients.

Peter Harper: [00:02:20] Yeah, I mean, it’s one of the things that we see regularly as far as a challenge is just getting folks. If they’re going through a substantial life of event or substantial liquidity then, their approach to risk has to change dramatically, I find, because at one point maybe their life has had a whole lot less complexity than it does today as a result of the transaction. How Steve have you seen those challenges around risk impact bonds? And how do you try and encourage them to think about them and deal with them?

Steve Martini: [00:03:12] Well, you know, there’s two different kinds of situations, you know: the hope for situation, which is they’ve engaged somebody like you or myself. Early, you know, a couple of three years out from the expected liquidity event, because then it gives us time to work with them, put certain processes in place and help prepare them for what they hope is going to be coming in a couple of three years. Doesn’t always happen that way. Sometimes we get brought in three months prior to liquidity and then it’s a lot harder.

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Steve Martini: [00:03:48] One of the terms I use a lot in this is there’s you’re going through two phases. One, when you’re operating, you’ve been successful, but you haven’t established large, certainly liquid net worth. And that requires a different type of planning and risk-taking because you want to put things and structures in place, but you don’t want to put anything in place too radical that would possibly affect the upcoming liquidity event. So you don’t want to get anything. You want tax efficiency, but you want for the buyer to be able to come in and understand what you’re doing. That’s step one. And the expression I always use there is on an aggressiveness scale at that place, you probably want to be somewhere around or five or six aggressiveness. You don’t need much more than that. And you don’t want to take the risk and make things too complex for yourself.

Steve Martini: [00:04:47] Once you’ve had the liquidity event, I think us as a firm, we’re still relatively conservative. But I think at that point, because the tax dollars are so much more material because now you’ve built your team – for sure – of multiple advisers, you can be a little more aggressive. Again, the tax benefits are more material. At that point, I still tell people to step ii up maybe to a seven or an eight because I think nine or 10 is not comfortable for a audit risk and not comfortable as far as the risk-reward. So we always tell people that point seven to eight aggressive, be prudent, think about the impact still and the risk involved. But at that point, again, dollars more material. You probably want to step it up a little bit and get, you know, get a little more creative.

Peter Harper: [00:05:44] You mentioned audit risk. How do you find that some of these choices can impact two things. One, valuation, right, being overly aggressive strategies implemented in a business priot to liquidity. It would be interesting to understand. And then audit risk. What role does that play in a client’s world?

Steve Martini: [00:06:16] Well, I think what happens and the couple the stumbling blocks I’ve seen is one, you want to be aggressive in your compliance. Here in the states, the state nexus issue is a big deal. Companies are very, very engaged and involved. Companies might not necessarily always want to know. They’re based in California. But, you know, you have to file in New York City because of A, B or C, and sometimes they won’t. And we’ve seen that become a hindrance in deals because the buy-side always wants to know your compliance is spot on. Then we’ve seen situations with offshore captive insurance. There’s some really aggressive, you know, positions you can take. But, you know, depending on who the buyer is, a lot of times they’re not going to like that. And then in due diligence and will be an ad back and will negatively affect the deal, the buyer might escrow more money to protect them for a couple of years post transaction. So that’s kind of the line where I say again that five or six, now’s not the time to do the micro captive, which, by the way, the IRS has published that they want to come out and audit it.

Steve Martini: [00:07:42] You attach a very, very ugly form to your return to say you’re participating in a micro captive and you create a tremendous audit risk for yourself. And if you’re worried about it, you can only imagine what the buyer is going to be worried about if once they acquire this company and what’s going to happen to them two years out. So that’s what I think.

Peter Harper: [00:08:05] Have you ever see an audit or any of this stuff like impact deal to the point where the deal hasn’t happened or is it always just been an impact evaluation rather than someone saying “Hey, listen this is too much”

Steve Martini: [00:08:19] The main thing I’ve seen it is in reps and warranties. I’ve seen it affect the valuation and for sure I’ve seen it affect the escrow hold on a standard deal. The escrow account might be five to 10 percent. I’ve seen it pumped up materially because of certain risk factors. I’ve seen the buyers put in a position where they can take less cash off the table and they have to do a more rollover equity. And one of my pet expressions from my clients, when we represent them on the sell side, is “whatever you get in cash, make sure you’re happy with because you should really go into this deal, assuming this is all you’re getting” because anything on an earn-out or rollover equity is totally on the comp. And that number certainly increase is dependent on things like structure, audit, risk, etc..

Peter Harper: [00:09:15] Sure, I mean, it’s really interesting, you know. I’ve been working a couple of deals recently where there’s a lot of weighting that’s been put around certain sort of growth factors and revenue and EBITDA growth. And, you know, a lot of times these things might be counted as a business plan that is being pushed forward by an acquirer.

Peter Harper: [00:09:40] But I think one thing that I think about is that you don’t actually know how much, really, the buyers think that they’re going to pay for something. Right. And a lot of that stuff can be baked into the back end. Right. So they’re thinking, as you said, you should be happy with what you’re getting up front, because that may be what it’s what the buyer thinks they’re going to pay.

Steve Martini: [00:10:07] And the other thing is, obviously, we’re in a challenging environment deal wise now anyway with covid. So you’re seeing a lot of deals, more backend geared. You’re seeing some valuations, let’s say, for most of the industries or the multiples got a little softer, some it’s gone higher. But for the most part, they’re a little softer and just a lot more on the earn-out side. So if you take that environment, I don’t think and I don’t think you want to add to it, at least at this point.

Peter Harper: [00:10:40] Yeah, that’s great.

Peter Harper: [00:12:23] So, Steve. We were just touching on the four. The importance of building out a strong adviser team for a multi adviser family office.Can you talk about ways in which you’ve seen that work really, really well for folks that have just had a major life change, major liquidity event and also the role of a controller and that sort of in that team for family that may not have had that support previously.

Steve Martini: [00:13:03] Well, I think those are those are two great things to highlight. I think the value of the team may be a little more obvious, but a good team of trusted advisers, the CPA, corporate council, Trusts and estate council, investment advisor, insurance adviser; they’re are working together.

Steve Martini: [00:13:25] It’s not, let’s say, quote unquote, a family office where it’s all in-house, but good experienced teams, especially teams like that that have worked together before. Offline, they’re bounce ideas off each other. You know, they’re kicking things around. They all have experience not just with the client, but with each other. And so it’s so much stuff goes on behind the scenes that they’ll bounce ideas, they’ll check each other and they’ll help put together a plan, one cohesive plan that makes sense and really kind of ties the family with a path going forward. And then the nice thing, assuming there’s enough net worth there of having that internal could be a controller – could be an accounting manager, is you have somebody with that financial expertise to help them execute on it, to make sure, “Yeah, we’ve put this trust and estate and we have these insurance policies tied to these trusts. And yes, these policies need to be paid with separate property funds, depending on what state”. And all these things a lot of times are beyond the reach of the most entrepreneurs who, quite frankly, in my experience, usually not the financial people. They’re the idea people. They’re the salespeople, they’re that person. They’re usually not the accountant of the family. Having that internal component, especially once you’ve had the liquidity event, just really helps the trusted advisor team and the family execute on the advice. So that’s really, really valuable. Having those two components is wonderful.

Peter Harper: [00:15:06] And you think it reduces risks? I mean, I think we were talking about this earlier. I think that, you know, I find that when you’ve got that key person involved, it’s more likely that the family has a proper grasp of things that they’re taking on.

Steve Martini: [00:15:27] Yeah, because, you know, that’s somebody that they can talk to every day. They’re not going to be talking to me or you necessarily every day. But they need somebody there because they’re that internal financial person is also going to follow up and explain. “And this is why we have to do it this way. And we have this entity and this second and third homes, and they’re an LLC”. That’s going to get, you know, not even for the one hundred million plus family, but for the 15 to 50 million. There’s some complexities involved to be efficient, reduce audit risk by making sure funds flow is proper. These are all things that are helpful to execute on. And even if it’s not a full-time in-house controller, there are groups you and I work with that can kind of take on that responsibility for these families. And then that becomes part of the team.

Peter Harper: [00:16:24] Awesome. A great answer. Well, Steve, thanks very much for dropping by. Really appreciate it. It’s great talking to you.

Steve Martini: [00:16:31] You too, buddy. Great catching up. Thank you.

Peter Harper: [00:16:31] Bye Bye