The Equity Monetization Strategy


With the recent fall of Bear Stearns and the not too distant collapse of Enron, the concept of not holding all your eggs in one basket often gets mentioned. If you work for a certain company and own many shares of the company that have been acquired over decades of service you are putting yourself into a very precarious position! Scores of people who worked for Bear or Enron not only lost their ability to earn an income (their jobs), but they may have simultaneously lost the bulk of their retirement savings – a crushing blow to say the least.

businessgirlatdesk.JPGSome people who own a large number of shares in a non-registered account may feel that they do not want to realize potentially significant capital gains even though they understand they are poorly diversified. Conversely, if the stock falls in value, your portfolio could be hit with some serious declines in value.

Enter the Equity Monetization Strategy. This strategy essentially allows you to sell your economic interest in your shares without having to dispose of them (physically or for tax purposes) until a later date, say five years from now. The share-owner needs to enter into a forward contract (a type of derivative) with a financial institution. The forward contract allows you to set a sale price for your shares for some time in the future.

Since you now know what you will be able to sell your shares for at a certain point in the future (even if the actual value of the shares goes down by then), you can then pledge your existing shares as collateral for a loan that can be used to create a diversified portfolio. The interest on this loan would be tax deductible to boot.

You have deferred the realization of taxes (for years if you so decide), and have created a more diversified investment portfolio in the meantime. The tradeoff is that you will have given up some upside potential by locking in the future sale price. (Conversely, if the securities go down or pull an Enron – you’d be laughing.) 

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Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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Showing 5 comments
  • Michael James

    This strategy significant costs. There is the interest cost on the loan and the cost of the expected negative return on futures contracts. These costs seem high compared to the benefit of delaying paying capital gains.

  • Preet

    Equity monetizations are normally associated with insiders (and I believe they now have to disclose them to public record). Some executives could have a pending million dollar tax hit. By using a forward contract they can mitigate short term price fluctuation of the portfolio if the stock they own is more volatile than the replacement holdings – and certainly they could win out. If the price of their stock is below the contract value, the financial institution would owe them money as well to make up the difference to the contract price.

    I wonder if there is a link to insider equity monetizations and price declines in the underlying stock thereafter… Hmmmm… :)

  • thickenmywallet

    Isn’t the price on forward contracts determined based on the value of the stock today. For example, if the stock is trading at $10 today, you enter into a forward contract for $15/share whereas if the stock was trading at $15/share then the contract would obviously be a premium on that higher share price.

    …the point being, aren’t you leaving money on the table if you enter into a forward contract for a good stock trading below its historical range? Not an expert on this so just speculating.

  • Preet

    You certainly could be leaving money on the table. Depending on how the contract is structured, if the stock is trading above the contract price by the end of the contract, you might have to pay the difference in cash to the financial institution. Certainly this would be part of your consideration in whether you would want to engage an equity monetization. You might be better off just holding onto the stock in some cases, and in some cases you might be better off selling the stock and taking the tax hit.

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