A prospect who had worked at a successful hedge fund was looking to start his own. After our first meeting with him, we learned that caring for his family, which included three children, was very important to him.
We discussed a window of opportunity, available during the initial stages of a new fund, to transfer wealth off his personal balance sheet and to his heirs in a tax-efficient manner. Together, we reviewed several techniques that revolved around the same principle: transferring assets at relatively low value into a trust to preserve greater wealth for him and his family as the value of the trust’s assets grow over time.
Owning your business
One technique required less cash, which can be a potential option during the start-up phase when significant funds are needed to cover operating expenses. This approach involves giving shares up to the gift tax exclusion amount. The law effectively requires gifting shares of general and limited partnership interests if both exist – a so-called “vertical slice.”1 Gifting a vertical slice would allow his interest to grow, free of transfer tax, over the life of the fund, thereby reducing his overall estate tax.
Another technique involved the creation of a grantor retained annuity trust (GRAT), an irrevocable trust that typically lasts anywhere from two to ten years and allows for the transfer of assets’ future appreciation, free of gift tax, to the next generation. As the principal, he could transfer general partnership and limited partnership interests as well as cash to a relatively long-term GRAT (e.g., seven years). The cash would be used to make the required annuity payments back to the grantor for the first few years, after which time a successful fund should be generating enough cash to cover the annuity payments. GRATs are often seen as a way to transfer significant wealth to the next generation without incurring gift tax; however care must be given to ensure funding of the required distributions.
Wider range of strategies
Because the founder was interested in preserving as much working capital as possible, he found the first approach preferable after weighing both alternatives carefully. These strategies are only a sampling of the range of customized strategies we offer not only for the launch of a new fund, but also for existing funds starting a new strategy.
1Treas. Reg. §25.2701-1(c)(4).