the variable prepaid forward contract an overview
a variable prepaid forward contract is a strategy used by stockholders to cash in some or all of their shares while deferring the taxes owed on the capital gains the sale agreement is not immediately finalized but the stockholder collects the money this strategy is typically used by investors who own a large number of shares in a single company and want to raise cash while postponing taxes understanding the variable prepaid forward contracta typical user of a variable prepaid forward contract might be a founder or top executive of a corporation who has accumulated a large amount of company stock that person might want to diversify their concentrated investments lock in profits in the stock or at the very least raise a large amount of cash the use of a variable prepaid forward contract allows that person to sell the stock to a brokerage company the investor is immediately paid between 75 and 90 of the current value of the stock but the transaction is not finalized until it is finalized the taxes on the capital gains are not due at that time the stockholder turns over the shares or the cash equivalent with a price range set in advance to protect against a substantial loss the practice is particularly useful under certain circumstances for instance some executives who are granted stock options are prohibited from selling them for a certain period of time also a large stock transaction by a company insider at any time makes investors nervous the variable prepaid forward contract neatly circumvents these obstacles since the contract establishes a floor and ceiling price on the final transaction it also protects the investor from a heavy loss if the stock gains dramatically in value before the transaction is finalized needless to say this practice is controversial and some think it should not be allowed technically a prepaid variable forward contract is a collar strategy which is a bundled long put option and short call option on a security however it has a third element the monetization of the transaction in the form of a loan against the underlying security while once fairly sophisticated these types of strategies have become more commonplace thanks to advancements in financial engineering naturally they also tend to draw the attention of the irs and financial journalists in 2011 the new york times ran a front page feature highlighting how ronald lauder the est e lauder cosmetics heir was artfully sheltering his compensation through a prepaid variable forward contract with executive pay at many multiples of the average employees compensation levels these types of strategies are popular targets for scrutiny 1 