If the stock market collapse wasn't proof enough that an undiversified portfolio can be dangerous, the Enron debacle has sealed the deal.
Yet, thanks to equity-based transactions, many entrepreneurs have a large portion of their wealth tied up in their own company's stock. If this sounds familiar, an exchange fund may be right for you. Exclusive, privately managed funds made up of a group of individuals' stock holdings, exchange funds accept your stock holdings in exchange for equivalent interest in the fund's portfolio.
"You get immediate diversification, you can exchange interest in a stock, and tax is deferred," says Diana Dessonville, executive vice president at San Francisco investment management firm Bailard, Biehl & Kaiser. "If you stay in the fund for seven years, you can walk away with a diversified portfolio without [capital gains] tax obligation."
But a good fund can be hard to find, and may require a hefty minimum investment, or may not accept your stock. It's worth a try, though. Notes Dessonville, "Investors [should] look for a fund representing a sector of the market they would like to participate in."
Stock It to 'Em
Once upon a time, pre-IPO options were a good deal all the way around. But life-and accounting-is becoming more complicated these days. Take, for example, the practice of issuing pre-IPO options to suppliers and customers. Just last year, awarding favorably priced pre-IPO options--dubbed "cheap stock"--was a common practice for growing companies and an economical way for an early-stage company to reward its most loyal partners. But this year, thanks to the SEC, it may become an expensive proposition.
Why the change? "The SEC is saying companies that issue cheap stock need to take a charge on their income statements for the difference between the price at which the stock was issued and the IPO price," explains Peter Knutson, associate professor emeritus of accounting at The Wharton School of the University of Pennsylvania.
Companies, in turn, argue that the pre-IPO valuations are accurate because the liquidity that the IPO itself delivers is what makes the shares more valuable. In the heat of the debate, the SEC charged the American Institute of Certified Public Accountants (AICPA) with developing a best practice resolution to the issue by year-end, says Knutson, who is serving on the AICPA's cheap stock task force. In the meantime, newly public companies should stock up on proof of value. "Until they come up with something, companies will be charged on their income statements unless they can provide satisfactory, documentable evidence that values used were justifiable," says Knutson. "The burden of proof is on the companies."
Jennifer Pellet is a New York City-based freelance writer specializing in business and finance.
- Bailard, Biehl & Kaiser
(650) 571-5800, www.bailard.com
- Eaton Vance Family of Funds
(800) 225-6265, www.eatonvance.com