I'm trapped in a gold mine!

[flotsamandjetsam]

Ok, I’m exaggerating a little. I've been reading and learning here since 2007. I want to start by thanking you all for the many intelligent and entertaining threads. I have learned so much about financing and living early retirement. I have been quiet because anything I have to contribute to a particular topic is usually said more eloquently by someone else before I can get my oar in the water.

I would like to retire soon but I am trapped by my work situation. With your advice, maybe I can cut this Gordian Knot.

I and DW are age 52. FI for a few years now through LBYM and steady saving. Most of my career has been as an engineer with megacorp. Ten years ago I decided to spice things up a little and throw off the comfort of corporate life to go to work for a newly formed startup technology company. I worked for equity for the first few lean years while we developed and marketed our technology. I built up a 15% ownership position before drawing a regular salary. Now, a few years later, the company is very successful. We have about 20 employees and sales are strong, about $14M per year, and growing. Earnings are strong, too, and the company has started to return profits to the shareholders. My startup adventure has been enjoyable and is also becoming financially rewarding.

Meanwhile, DW has worked for government for a little over 20 years. Her job security has enabled my startup adventure. We also have our health insurance through her employer. Some days her work is interesting and satisfying and some days she is frustrated by bureaucratic inefficiency. She went to a reduced work week when our son was born 19 years ago and has never gone back to full time. She is in FERS and will become eligible for a small pension and continued health insurance in a few years (reduced, of course, by the number of years prior to 62 if she retires early).

Financially, we are in good shape for retirement. Having set aside funds for our son's college expenses, we can live our current lifestyle at a 3% SWR (not including the startup stock). That's because we have modest appetites for most things and have lived below our means our whole careers. DW and I are on the same financial wavelength. We became FI years ago by saving about 50% of our after-tax income.

My problem is too much of a good thing. I would like to extricate my financial interest from the very profitable but risky business that I sweat-equitied my way into. I cannot sell my stock except to the majority owner (CEO). He is not interested in buying it at any reasonable price. The company is an S-corporation and the profits are passed (on paper) as ordinary income to the shareholders. This is causing us enormous tax liabilities. The company is making distributions sufficient to cover our large federal and state tax payments. In the last couple of years I have received distributions in excess of taxes to the extent that I have now recouped my sweat-equity investment. Going forward, the excess distributions are gravy.

First question: In general terms, how should I compensate for this high risk/high reward investment in our portfolio? We are about 70/30 now, not including my stock in this company. The value of my piece of the company is roughly equal to the rest our investments, combined. I could move to more bonds to balance things out, but this doesn't seem like a good time to buy bonds.

The second question is one of oversight: I feel like I need to be there to keep an eye on things. If I retire, I will lose access to information. I trust the majority owner to operate the business well but he doesn't always have the interests of all the shareholders in mind. I guess I could schedule regular visits to the company offices, maybe once per quarter, to review the financials and chat with the CEO. I have to be sure they cover our estimated taxes each quarter. So far, they have not squeezed me on taxes, but it could happen if relations sour.

Third question: Any ideas on how to persuade the CEO to redeem my stock? More than a year ago we had some discussions in that direction but it came to nothing. I have offered financing, contingencies, partial sale, etc. It seems that only a very low price would be attractive. I think I have a realistic idea of what my stock is worth, including discounts, but that is moot if there is no buyer. The majority owner may be worried that if he buys me out I am more likely to move on. I hope that some day the company will be acquired but I am not holding my breath. There is no exit strategy or even a business plan.

Thanks for listening. Now that I'm out, I will try to participate more.

[freebird5825]

I cannot answer your questions, but I wanted to welcome you to the "visible" spectrum of the forum.

[JBmadera]

welcome! I'm not able to provide any insight into your concerns but I would suggest you check out bogleheads.org, esp for the stock related issue.

good luck!

[Texas Proud]

Quote:

Originally Posted by flotsamandjetsam Ok, I’m exaggerating a little. I've been reading and learning here since 2007. I want to start by thanking you all for the many intelligent and entertaining threads. I have learned so much about financing and living early retirement. I have been quiet because anything I have to contribute to a particular topic is usually said more eloquently by someone else before I can get my oar in the water. /snip/.

Have not read the rest of your post... but decided to respond to this...

But first... welcome...

There are a number of people who are excellent writers and they seem to say what you want to say... or even things you had not thought of... better than you...

there are also some who write in short snippets that you have to 'read between the lines' if there were any lines because there is usually just one...

But I have found that some of the post that are not as eloquent do make a point... and even if you do not think it makes a difference.. it just might.. SOOOO, post away...

[Coach]

Welcome to the forum! What an interesting dilemma.

Regarding the startup stock and asset allocation, I think if it were me I'd just ignore it and figure my allocation based only on my other investments. The startup stock is just too risky, too large, and too illiquid.

I don't have any great ideas on how to get out. Your idea of quarterly visits seems like the best option. Or perhaps some kind of semi-retirement, working enough to keep an eye on things, but beginning a transition to retirement.

Good luck!

Coach

[Trawler]

First congrats on becoming FI and building a successful business. In reading your story I see that you can remain FI in ER reguardless of the stock value or its earnings. Thus you may want to look your assets as retirement assets and the other assets. In other words set up you assets in two buckets. I call the assets I have that I will use to determine my SWR the Goose Portfolio as I need this on to lay the golden egg every year. The other my Gravey Portfolio.

Question 1.
I would not use the stock as part of evaluating overall portfolio risk.
I would not use a value in determining total retirement assets and SWR Goose assets.
I would treat the value in the gravey portfolio

Question2
S-corp tax liability- I would think that over a fiscal period of a tax periodover time profit and tax go hand in hand thus it is a personal cash flow issue? In other words you may have to pony up on quarterly tax until earnings distributed. if that is the case you may want to quantify what that tax burden would look like and analyze taking $$ out of retirement assets (Goose Portfolio)and putting into non retirement assets (Gravey Portfolio) and see if the Goose porfolio will still lay the amount of golden eggs you need each year.

Q3- I have no real sugestions other than trying to force an exit plan . In other words if CEO real fear is with you gone the comany value drops you may consider if sell at low price today and leave or offer stay for a period of time if he would agree to buy at a predetermined price formula.

[RoccoPacco]

I am members of both this forum and the bogleheads.org forum. I encourage you to ask this question over at the bogleheads as well.

[BigNick]

A couple of random thoughts:
- If you are 70/30 plus another 100 in the company, you are in fact 85/15 with 50 of the 85 being in one small cap in a volatile sector. I would run, not walk, out of a big chunk of stocks, especiallt anything to do with tech.
- What do the company's articles of incorporation (not sure about the term) say about shareholders? If you die tomorrow, can you pass your shares to DW even though she will not be working at the company? If you become disabled and unable to work, is the company obliged to apply a fair market value to your shareholding? If I were in your position and didn't know the answer to that, I would consider consulting a lawyer.

[flotsamandjetsam]

Thanks for the warm welcome! I really appreciate the responses.

Two posts, from Trawler and Big Nick, reflect my dilemma. I can either ignore the startup stock in our portfolio on the theory that it could go poof at any time, or I can attempt to balance things out by shifting away from tech stocks where possible...What to do?

Big Nick, There is a buy-sell agreement in place but it doesn't cover voluntary sales. There is a process (triad of valuations) for setting a price in case of death, etc, but even then the company is not required to buy the stock back. I did work with an attorney when the situation was formalized several years ago.

RP, I will look into the Bogleheads. Thanks.

[flotsamandjetsam]

Quote:

Originally Posted by Trawler Q3- I have no real sugestions other than trying to force an exit plan . In other words if CEO real fear is with you gone the comany value drops you may consider if sell at low price today and leave or offer stay for a period of time if he would agree to buy at a predetermined price formula.

I'm flattered but I doubt my leaving would affect the value of the company. But, it would look better in an acquisition to have all the founders still on board. There may be some leverage there.

[BigNick]

Quote:

Originally Posted by flotsamandjetsam I can either ignore the startup stock in our portfolio on the theory that it could go poof at any time, or I can attempt to balance things out by shifting away from tech stocks where possible...What to do?

If your retirement plan can be met with a value of $0 from the startup stock, and if it turns out to be worth $$$$ you then buy a yacht or something else you don't need, that's fine. Otherwise, it's part of the portfolio, and it has to meet the rules which you've set for the portfolio. Many of us have a little "mad money", but it can take quite a bit of honesty to determine that it truly is such.

Imagine being told that your startup stock has to go into trust for your great-great-grandkids to open in 99 years time. How would that make you feel?

[haha]

Quote:

Originally Posted by flotsamandjetsam I'm flattered but I doubt my leaving would affect the value of the company. But, it would look better in an acquisition to have all the founders still on board. There may be some leverage there.

Is the CEO actively looking for an exit? If so, stand pat and don't spend a lot of time geeking on allocations because a sale of the company is likely the only way that you are going to get much of your equity out. If you then go along a few years and it begins to look like this is not going to happen, re-evaluate.

Ha

[Texas Proud]

Quote:

Originally Posted by flotsamandjetsam Thanks for the warm welcome! I really appreciate the responses. Two posts, from Trawler and Big Nick, reflect my dilemma. I can either ignore the startup stock in our portfolio on the theory that it could go poof at any time, or I can attempt to balance things out by shifting away from tech stocks where possible...What to do? Big Nick, There is a buy-sell agreement in place but it doesn't cover voluntary sales. There is a process (triad of valuations) for setting a price in case of death, etc, but even then the company is not required to buy the stock back. I did work with an attorney when the situation was formalized several years ago. RP, I will look into the Bogleheads. Thanks.

I work for an S corp and have a very small stake in the company... so I know where you come from...

First... what does the agreement say about distributions Our's states a 100% distribution as long as corp needs are met...

Your company might not be able to buy back the stock.. the company has to have enough equity to do it (IOW, the equity in the company goes down by whatever they pay you... and it can not go negative).. this is a problem with our company as they did buy shares and now our equity is very low for a firm our size...


I would also think that if you do not sell your shares, with 15% of the stock you should be able to get on the board. Our biggest shareholders are also board members. The board sets the pay of the CEO and distribution policy...


You can not force anybody to buy your stock... so in a way you are stuck with an illiquid investment, but if they do the right thing it can pay off well..

[flotsamandjetsam]

Quote:

Originally Posted by haha Is the CEO actively looking for an exit? If so, stand pat and don't spend a lot of time geeking on allocations because a sale of the company is likely the only way that you are going to get much of your equity out. If you then go along a few years and it begins to look like this is not going to happen, re-evaluate. Ha

The CEO seems verrry comfortable in the corner office. I don't see a sale anytime in the next year. I need to plant the idea in his subconscious somehow...

[FIREd]

Our situation is a bit different. We have a large portion of our portfolio invested in my wife's company stock. The company is a small cap stock. The stock itself is very volatile (it lost about 90% of its value in 2007-2008 but came back with a vengeance in 2009-2010). And because we can only trade it when the trading window is open a few times a year, it is only moderately liquid.

Given this situation, I actually include the company stock in our asset allocation. Basically we have a barbell portfolio. The stock portion of our portfolio has a very high beta due to the large amount of company stock, so I compensate by having a larger than usual fixed income allocation on the other side.

When the trading window opens and the price is right I sell large chunks of company stock and rebalance accordingly.

That's has been my strategy at least. But since your stock is completely illiquid, it may not be the best strategy for you.

My mother in law has a bit of money invested in the stock of a private company her husband used to work for. The stock has been illiquid for 15 years. She tried to have management buy her stock back last year but they refused. She basically considers her stock certificates worthless at this point.

[Texas Proud]

Quote:

Originally Posted by flotsamandjetsam The CEO seems verrry comfortable in the corner office. I don't see a sale anytime in the next year. I need to plant the idea in his subconscious somehow...

The problem is that value to him of being in the corner office is a lot more than it is to you... IOW, most do not want to give up that power...

Also, a lot of 'owners' think that their company is worth a lot more than it really is worth... our company paid to have a formal review of the value of the company.. and the price for a minority share was $13 and if you had a majority it was $20... since the biggest shareholder thought it was worth $50 it was a bit of a shock.. the good news is he has hussled a lot in the past two years to make the firm more valuable... I would put a price of $28 to $35 now...


What do you really think the value would be What would it be if the CEO, the other founders and you were not there I bet the price difference is a lot... What protections are there if the CEO got hit by a bus tomorrow? How low would the stock go?

Most small Sub S corps are only worth the value of their top people.. if they go, there is not much value left...

[flotsamandjetsam]

Quote:

Originally Posted by Texas Proud I work for an S corp and have a very small stake in the company... so I know where you come from... First... what does the agreement say about distributions Our's states a 100% distribution as long as corp needs are met... Your company might not be able to buy back the stock.. the company has to have enough equity to do it (IOW, the equity in the company goes down by whatever they pay you... and it can not go negative).. this is a problem with our company as they did buy shares and now our equity is very low for a firm our size... I would also think that if you do not sell your shares, with 15% of the stock you should be able to get on the board. Our biggest shareholders are also board members. The board sets the pay of the CEO and distribution policy... You can not force anybody to buy your stock... so in a way you are stuck with an illiquid investment, but if they do the right thing it can pay off well..

Thanks, Texas Proud.

There is no statutory requirement to distribute profits but I have an agreement that timely distributions will be made to cover tax payments. There are weasel words in there about sufficient funds being available that could be used to cause me trouble, not that I am expecting trouble.

BTW, I am on the BOD. The board meets once a year as a formality. Not much leverage there.

[flotsamandjetsam]

Quote:

Originally Posted by Texas Proud The problem is that value to him of being in the corner office is a lot more than it is to you... IOW, most do not want to give up that power... Also, a lot of 'owners' think that their company is worth a lot more than it really is worth... our company paid to have a formal review of the value of the company.. and the price for a minority share was $13 and if you had a majority it was $20... since the biggest shareholder thought it was worth $50 it was a bit of a shock.. the good news is he has hussled a lot in the past two years to make the firm more valuable... I would put a price of $28 to $35 now... What do you really think the value would be What would it be if the CEO, the other founders and you were not there I bet the price difference is a lot... What protections are there if the CEO got hit by a bus tomorrow? How low would the stock go? Most small Sub S corps are only worth the value of their top people.. if they go, there is not much value left...

I think my estimate of the value of the company is fairly realistic. I consulted with a valuation specialist and he let most of the air out my original estimate. I have discounted for minority ownership and lack of marketability. Of course the real value to me is whatever the majority owner is willing to pay for it. An acquisition would be better.

The company does not have enough cash on hand to buy me out outright. I have offered to take a note with flexible payments and also to sell in installments, to no avail.

If I left, I would become a nonparticipating owner. That might seem wrong enough to the CEO that he might reconsider. But, I'm a dog person. After all these years I still can't read his mind.

[flotsamandjetsam]

Quote:

Originally Posted by FD Given this situation, I actually include the company stock in our asset allocation. Basically we have a barbell portfolio. The stock portion of our portfolio has a very high beta due to the large amount of company stock, so I compensate by having a larger than usual fixed income allocation on the other side.

Barbell sounds good. I have to be a little careful with interest income because the startup S-corp has thrown us into the top bracket. Not that we see all the money.

[Danmar]

Interesting problem. What you really need is a
iiquidity event mabe an IPO or similar. This would create a way for you to get your equity out. Any prospect of that?