Variable Prepaid Forward Contracts

A variable prepaid forward contract (VPFC) is a financial arrangement that lets a shareholder receive immediate cash for a block of shares while delaying recognition of capital gains until a later settlement date. It’s commonly used by founders, executives, and other holders of concentrated stock positions who want liquidity or diversification without an immediate taxable sale.

Key takeaways

Tax deferral: The seller receives cash up front and typically defers capital gains tax until the contract settles.
Partial immediate liquidity: Sellers usually receive about 75%–90% of the share value up front.
Variable settlement: The final number of shares or cash exchanged depends on the stock price at settlement, subject to predefined floor and ceiling levels.
Structure: A VPFC combines option-like protections (a collar of puts and calls) with loan-like monetization against the underlying shares.
Scrutiny and complexity: These transactions are sophisticated, may attract regulatory and media attention, and require careful legal and tax advice.

How a VPFC works

The shareholder enters into a contract with a counterparty (often a broker or dealer).
The counterparty pays an upfront amount—typically 75%–90% of the current market value—while the shareholder keeps economic exposure to future price moves within defined limits.
At a future settlement date, the contract is finalized: the shareholder delivers a number of shares (or cash equivalent) determined by formulas in the contract. The outcome is bounded by a floor and a cap so the seller is protected from extreme downside and gives up some upside above the cap.
Capital gains tax is generally triggered at settlement rather than when the upfront payment is received.

Technical mechanics

Collar component: The arrangement is economically similar to holding a long put (floor protection) and selling a call (capping upside).
Monetization/financing: The upfront payment functions like monetizing the position—similar to receiving a loan secured by the shares—while maintaining a residual economic interest.
Variable settlement: Because the final delivery is contingent on the share price, the contract is “variable” rather than a fixed forward sale.

Benefits

Immediate liquidity without an outright taxable sale.
Ability to diversify or meet cash needs while postponing tax.
Limits the seller’s exposure to large unfavorable price moves via contractual floors.
Can avoid signaling effects and insider sale restrictions that accompany open-market transactions.

Risks and drawbacks

Complexity: Requires bespoke documentation and professional advice (tax, legal, accounting).
Regulatory and tax risk: Tax authorities may challenge the transaction’s characterization; media and public scrutiny can follow for high-profile users.
Opportunity cost: The cap on upside can limit participation in strong future gains.
Counterparty risk: Dependence on the counterparty’s creditworthiness or the broker’s terms.
Fees and structuring costs: Transaction costs and financing economics can be significant.

When investors use VPFCs

Corporate insiders who face trading restrictions or want to avoid market disruption from a large, immediate sale.
Shareholders with concentrated positions seeking liquidity or diversification without immediate tax liability.
Situations where the seller prefers a negotiated, private transaction over selling in the open market.

Bottom line

A variable prepaid forward contract is a sophisticated tool to obtain near-term cash liquidity from appreciated stock while deferring capital gains tax and managing exposure through floor and ceiling provisions. Because of its complexity and potential regulatory scrutiny, it should be considered only with thorough legal, tax, and financial advice to evaluate structure, costs, and compliance risks.