Strategic Borrowing: Protecting Your Wealth During Acquisitions and Investments
Employing strategic borrowing to fund an acquisition or investment can, in a way, allow the borrower to have their cake and eat it too. The infusion of liquidity can alleviate the need to divest or sell other assets, meaning their current financial strategies can remain intact.
- Strategic borrowing can be a powerful tool to achieve both short- and long-term goals, including bridging liquidity gaps and maximizing investment potential.
- Divesting existing investments to fund a purchase could trigger capital gains taxes or force liquidation at an inopportune time.
- While purchasing the assets outright may be a viable option, financing large purchases such as private aviation, yachts, and fine art with structured or securities-based loans may be a better option.
Timing Your Borrowing
Bridging liquidity gaps with short-term financing
Time-sensitive opportunities, transitional periods, and other “bridge events” like these often require access to liquidity:
- Real estate transactions that are complex, lengthy, and/or time-sensitive, or where there is a timing difference between the sale of one property and the purchase of another.
- Sale of a financial asset is delayed due to timing restrictions (e.g., restrictive redemption periods imposed by alternative investments like private equity funds or hedge funds; insider trading windows).
- A gap until a liquidity event occurs, such as an IPO or the sale of a private company.
- Beneficiary distribution and gift obligations due when trust assets are illiquid and market timing is unfavorable. Take the example of a trust designed to distribute income when the beneficiary turns 25, which could contain mostly private company shares. If the beneficiary’s 25th birthday occurs at a time when the company’s shares are at an all-time low, it would be detrimental to liquidate the shares to fund the distribution.
- An individual passes away with significant estate tax obligations or other liabilities—and liquidating the estate’s assets too quickly could be detrimental to its beneficiaries.
Short-term financing can be a valuable tool for bridging these liquidity gaps and, in some cases, providing quick access to funds when needed.
Maximizing investment potential with long-term leverage
Longer-term leverage allows you to tap into the value of financial assets, such as low cost-basis restricted stock or private equity investments, without having to sell them.
It can also help you access liquidity in an illiquid asset you own, such as an aircraft, yacht, or collectible asset.
This strategy enables you to stay fully invested and make opportunistic investments when desired, while smoothing out episodic cash flows.
Additional events where long-term borrowing may make sense include:
- Capital calls - A private equity or venture capital fund has a subscription line of credit to ensure capital calls can be met without raising the funds from investors frequently and with little notice.
- Smoothing out the irregular income from your investments and businesses with a long-term loan can reduce the risk of being forced to sell assets to raise liquidity.
Case study: Monetizing a non-income-producing, appreciating asset using securities-based lending
- A Goldman Sachs client with a significant modern and contemporary fine art collection sought to leverage the value of their art pieces to both fund co-investment obligations in their private equity funds and purchase new works of art. The individual’s wealth was concentrated in illiquid investments, and they needed a solution to extend the holding period on appreciating assets.
- A loan was secured against the value of their fine art collection, providing flexibility to make opportunistic purchases. The securities-based line of credit had the added bonus of allowing them to retain a favored asset while meeting obligations.
Considerations
Whether you are borrowing on a short- or long-term basis, careful consideration should be given to the appropriate level of leverage to mitigate the risk of margin calls, as brokers may be obligated to enforce margin requirements and can liquidate positions without prior notice. Planning and management are essential to ensure that leveraging assets does not create financial strain and that the timing of asset sales remains under your control.
Three Potential Solutions for Short- or Long-Term Financing
There are a number of lending solutions available, each of which comes with its own benefits, considerations, and tax or other financial planning implications.
Securities-based lines of credit
A securities-based line of credit offers significant optionality and flexibility, particularly when established in advance. It allows you to act quickly on high-potential investment opportunities, such as a lucrative real estate deal, without the typical delays that come with securing new financing. This can be helpful in competitive markets where timing can be crucial.
Asset-backed loans
This specialized financing is secured by existing assets, such as real estate, aircraft, or fine art. The loan can provide access to liquidity for businesses or individuals who own these valuable assets but have limited cash flow. The lender's risk is reduced by the valuable collateral, potentially leading to more favorable loan terms than unsecured loans.
Subscription line of credit
A subscription line of credit is a specialized financing tool designed for private equity firms. It allows the firm to draw down capital from its investors as needed, rather than requiring a full upfront commitment. This provides the firm with greater flexibility and liquidity to make investments, manage cash flow, and respond to market opportunities. The line of credit is typically secured by the firm's investment portfolio, and can be structured to meet the specific needs of the firm and its investors.
Case study: Financing a residential property using securities-based lending
- A Goldman Sachs client was looking to purchase a vacation residence. The seller was only accepting cash offers, making speed a critical factor in the transaction.
- The client was also interested in renovating the home shortly after purchase. Based on the client’s balance sheet, the Goldman Sachs Lending Team presented options for securities-based lending and traditional construction financing. The client found construction financing too restrictive and opted for the flexibility provided by a securities-based line of credit. This allowed the client to quickly close on the home, and after the deal was settled, the client used the remainder of the securities-based line of credit to pay for extensive renovations.
It is critical to consult with your wealth and tax advisors and lending professionals prior to taking action.
Conclusion
The strategic use of borrowing can be a powerful tool to create financial flexibility and capitalize on opportunities with precision. Goldman Sachs offers a variety of lending solutions which can be customized to a borrower’s specific situation.
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