Road to wealth: Cashing out
A small-business owner sells his software company for $6 million and gets help on how to invest for the future.
(FSB Magazine) -- Last March two of the most exciting moments in John Gravely's life happened at once. His daughter, Taylor, was born, and - via his cell phone from the hospital - he worked on a $6 million deal to sell his software company.
It's a story most entrepreneurs dream about, but - like a new baby - the arrival of a new fortune brings with it monumental responsibilities and sleepless nights. Gravely, whose deal required that he stay on at c360 (c360.com), the Atlanta software company he co-founded in 2001, for a period after the sale, says his primary concern hasn't been buying a boat or picking out a plane but ensuring that the company stays in good shape.
He's also focused on protecting his new wealth - 40 percent of which was issued in stock in CDC Corp. (Charts) (cdccorporation.net), the publicly traded Chinese company that bought c360. As is often the case with these deals, the stock is issued in restricted shares, meaning among other things that Gravely can't sell it for at least one year. "My biggest risk is all that stock," he says. "I believe the company will be successful, but what if there's a downturn in the market?"
Gravely, 40, admits that there's a "settling-in period" as he tries to get used to life as a man of means. "I was never a rich guy," he says. "I never had family money." But he did have great bloodlines: His father was a serial entrepreneur who dabbled in car washes, gas stations and real estate in Charleston, W.Va. By the time Gravely got to college, he had launched his own company, The Clemson Special, a weekly entertainment guide, which generated about $300 a week in advertising sales.
Upon graduation he worked various jobs, from construction to consulting, and invested all the money he saved into Home Depot (Charts) stock, which rose enough to finance his next investment- an MBA in international business. After a series of jobs in professional services, Gravely struck out on his own in 2001 with Jeremie Desautels, a partner from a previous job, and a $14,000 investment.
When the two were ready to launch their first product, customer-relations management software (more simply put, tools for salespeople), cost concerns sent Gravely to Bangalore, India, to contract production. The software was a hit- before long it was delivered in eight languages and offered by more than 650 resellers worldwide. By 2005, c360 was doing $2 million in revenue, and by 2006 four companies were interested in buying it.
Selling it was a "no-brainer," Gravely says. "Like Seinfeld, I wanted to quit when we were on top." He also wanted the security. He and his wife each had some savings in IRAs and 401(k)s ("the average amount for people our age," he says), but they were concerned about saving enough and now, as parents of two, were worried about the cost of college tuition. And while the Gravelys owned their home, they needed a bigger house and couldn't afford to move.
Those worries are now in the past. Not only did the cash proceeds from the sale of the company help alleviate the budget squeeze, but the stock he received has skyrocketed since the purchase- to more than $8 a share from $4. Gravely will receive the money in eight installments over 24 months.
Of course there are tax consequences: He will have to pay long-term capital gains taxes on the cash allotment, but he will be able to defer paying taxes on the stock until he sells his shares. Gravely put the cash earned from the sale, combined with previous savings, into three index mutual funds at Vanguard (one in domestic stocks, one in international stocks and one in bonds), and he is looking into financial tools to protect his CDC Corp. stock.
Anthony Guinta, a principal at Homrich & Berg (homrich-berg.com), a fee-only wealth-management firm in Atlanta that works with high-net-worth individuals, says Gravely's No. 1 priority - to protect the value of his stock, since he can't sell it for some time - makes sense. Different hedging strategies do this, such as exchange funds (where the holder of a large block of stock exchanges those shares for interest in a diversified portfolio of securities) or synthetic investments such as an equity collar (which guarantees the stock won't fall below a certain price).
After weighing the details, Guinta recommends a variable prepaid forward contract, another financial tool that puts a range around the value of the investment but that, unlike the collar, yields cash upfront. "In essence it's like taking a loan on the value of the stock," says Guinta.
At the end of the term, Gravely can give the counterparty the stock and keep the cash (incurring a capital gain on the sale) or he can get the stock back and pay cash to settle up. The IRS recently began scrutinizing these contracts, but Guinta believes it's still a good fit for Gravely as long as he's familiar with the regulations.
As Gravely starts to see proceeds from the sale of the company, Guinta recommends strategies to minimize taxes and to achieve balanced growth. On the tax front, Gravely needs to plan around the alternative minimum tax (AMT) because he'll have a big state income tax bill on the gain from the sale of his business. Under the AMT Gravely will not be able to deduct his state income taxes. "He should consider shifting state tax payments [i.e., prepay when possible] to years when he pays no AMT," says Guinta. "That way, the state tax deduction can be used."
To achieve more stable growth, Guinta wants Gravely to consider making changes in his portfolio, now spread among three Vanguard index funds. "It's tax-efficient, low in fees, and a valid approach, especially when you are not sure what you'd like to do with the money," says Guinta. "But I'd like to see him add real estate, natural resources and hedge funds." He acknowledges that some of those may sound risky, but adds that they should lower the overall volatility of Gravely's portfolio.
Guinta recommends a "starting point" allocation of roughly one-third in U.S. stocks (right now he's recommending large-cap stocks), about 15 percent in international stocks, 20 percent in hedge funds, 15 percent in bonds, and the rest in cash, private equity, real estate, and commodities.
Guinta notes that Gravely must address other planning issues. The first is insurance. "Whenever you come into new wealth, you have to revisit your umbrella policy and bump it up equal to your net worth," says Guinta. "What if you get into a car accident? What if someone sues you? Everything can be lost if you're not properly insured."
The second major issue is estate planning. Guinta commends Gravely on already having a will and suggests that he should next set up irrevocable trusts for the benefit of his children. Specifically, he would assign a trustee to oversee any monies contributed now or in the future, and determine the ages at which the kids may access the money.
Gravely is in the process of selecting an attorney to help him set up the trusts. He's still evaluating strategies to protect his stock investment and, since speaking with Guinta, has dramatically increased coverage under his umbrella insurance policy.
As for what's next, or the "go-to," as some financial planners and business brokers call life after selling a company, Gravely admits he's not sure. If he starts another business, he says it will probably be in an area related to one of his passions - perhaps music, travel or the outdoors.
For now, though, life hasn't changed that much. Gravely still goes to the office every day and still drives a 2002 Volkswagen Passat. "I'm the same guy," says Gravely. "I haven't done anything outrageous." After all, he adds, "I already bought the biggest purchase- peace of mind."