Tech millionaires chase billionaire tax shields with ‘swap fund’

SOARING stock prices have turned thousands of tech workers into millionaires whose holdings are concentrated in a single company. A California startup wants to connect them with a tool used by billionaires to diversify, access cash – and sidestep big tax bills.

Known as an exchange fund or a swap fund, the product is familiar to the super rich. Now, share-price rallies at companies such as Meta Platforms and Nvidia are creating an opportunity to offer the structure to moderately wealthy techies as well, says Srikanth Narayan, founder of San Francisco-based Cache.

“The mission is to make these financial products – that have typically been in the upper echelon – available more broadly,” said Narayan, a former engineer at Uber Technologies. “All of my friends and colleagues are talking about the same thing, which is that more of their net worth is tied up in a single stock.”

The catch for smaller investors has been that swap funds typically cater to customers willing to invest US$1 million or more. But Cache has lowered the investing minimum to US$100,000. One drawback: While customers retain ownership of their stock, they’re barred from withdrawing it for seven years.

Cache’s swap-fund offering enables participants to pool their stock holdings together, creating a more diversified collection of assets. Investors then get shares of the fund equivalent to their contributions, giving them the benefits of more varied holdings without having to sell their stock.

Lot at stake

If the goal is the democratisation of tax avoidance, there’s a lot at stake for California, which increasingly relies on Silicon Valley’s bounty to fund state government. Equity-based pay from the state’s four most valuable companies – Meta, Nvidia, Apple and Alphabet – accounted for an estimated 6 per cent of California income-tax withholdings last year, up from 4 per cent in 2019.

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“With such strong stock performance at tech companies over the past year, we are watching incoming tax receipts closely,” said Chas Alamo, an analyst at the California Legislative Analyst’s Office, the state’s nonpartisan budget adviser. “Will recent stock gains propel state revenues as they have historically or has that historical relationship shifted?”

With US$50 million in investment commitments so far, Cache isn’t big enough to dent state finances. But the waiting list is much larger, with almost 1,500 people looking to place US$1.2 billion, the company said. Cache is currently working on only its third swap fund, and if the startup prospers, others like it are likely to emerge. 

Another product offered by Cache allows users to borrow as much as 90 per cent of the value of their holdings, higher than the margin loans typically available to retail investors, Narayan said.

The loan structure, known as a “prepaid variable forward” has long been offered to high-net worth individuals who can access cash without selling stocks and incurring a tax burden.

Under Cache’s structure, the user continues to hold their shares. If the stock crashes, the structure minimises losses to a threshold. 

In the 1960s, the federal government tried to squash exchange funds by banning tax-free swaps into partnerships with more than 80 per cent of their assets in liquid investments such as stocks. Wealth managers skirted the measure by putting 79 per cent of the fund in liquid assets and the rest in holdings such as real estate.

“There are statutes that tried to reign it in, but they aren’t very effective,” said Mark Gergen, a tax law professor at the University of California at Berkeley. “It’s just something that’s been tolerated, though most people recognise it shouldn’t be.”

Billionaires such as software entrepreneur David Duffield and Snap co-founder Robert Murphy have used it, according to SEC filings. So has Senator Mitt Romney, the New York Times reported.

There’s a limit to how much stock of a particular company Cache can accept because the swap fund is designed to mirror the tech-heavy Nasdaq, Narayan said. Currently, he can bring in more Amazon and Microsoft shares, and he’s seeking stock from non-tech Nasdaq companies such as PepsiCo and Costco Wholesale.

“It’s a balancing act, we have to keep pulling the right levers so that the right stocks come in,” he said.

‘Open season’

Cache is planning for growth. It recruited a former Goldman Sachs Group vice-president to head investments and worked with attorneys from the law firm Shearman & Sterling. 

Kintan Brahmbhatt put in about half-a-million dollars of Amazon shares. He said he wanted to defer the taxes he would have to pay if he sold the shares, while enjoying diversification that will protect his holdings if the e-commerce giant unexpectedly stumbles.

“I still have stocks that were issued to me in 2010,” he said.

More lucrative tax breaks such as Qualified Small Business Stock, or QSBS, are available for early investors in Silicon Valley startups, said Christopher Karachale, a tax lawyer at Hanson Bridgett in San Francisco.

“If you think exchange funds are a good deal, QSBS is an even better deal,” Karachale said.

But Cache’s target market – long-term employees of Nasdaq companies – often don’t qualify for QSBS. And if they sell shares from their companies to diversify their investments, the combined federal and state tax rate on capital gains can be as high as 49 per cent in California.

“It’s the life cycle of a tax avoidance scheme,” said Daniel Reck, an assistant professor of economics at the University of Maryland. “It starts at the top, it’s tested out, and if tax authorities don’t crack down hard – or determine that it’s fully legal – then it’s open season.” BLOOMBERG