What to know before redeeming your Collective LP interest

As we approach the end of each fiscal quarter at Collective, we know a number of the limited partners (“LPs”) in our funds are considering redeeming their partnership interests. This article is an overview of the redemption process and some important tax consequences and other factors you might consider before redeeming.

Redemption Process

The redemption process depends on whether or not the LP is redeeming their limited partnership interest to pay off a maturing Exchange Loan^(*).

Redemptions not in connection with Exchange Loan payoffs

Redemptions of limited partnership interests not in connection with an Exchange Loan maturity are processed on the last day of each fiscal quarter. LPs wishing to redeem should request a Redemption Request Form from fundops@collectiveliqudity.com. The form must be completed and submitted at least 90 days before the applicable redemption date. So, for example, the last day to submit a Redemption Request Form for the December 31, 2024 redemption date would be October 2, 2024. Requests received after the deadline will be processed on the last day of the following quarter.

Payment of the redemption proceeds are wired to the LP after the fund administrator (i.e., SS&C) finalizes the Net Asset Value (“NAV”) of the Exchange Fund as of the redemption date. It typically takes 30-45 days after the redemption date for this calculation to be completed. The redemption proceeds are wired out within 2-3 days after Collective receives the NAV calculation.

Redemptions in connection with Exchange Loan repayment

Because Exchange Loans are secured by the LP’s partnership interest, LPs with outstanding loans must repay their loans before they can redeem their partnership interest for cash. Prior to their Exchange Loan’s maturity date, each LP must decide whether they will: (a) refinance their Exchange Loan, (b) repay the loan with cash, or (c) redeem their LP interest and use the proceeds to repay their loan.

LPs wishing to redeem to repay their loan must submit a Redemption Request Form (available by emailing fundops@collectiveliqudity.com). Redemptions for loan repayment are processed on the maturity date of the loan. That redemption proceeds are wired by Collective to the Lender. LPs who would then like to redeem their residual LP interest (after repaying their loan), should then follow the process described above.

Note that all redemption requests and redemptions are subject to the terms and limitations set forth in each LP’s Exchange Fund Limited Partnership Agreement.

Significant Tax Consequences of Redemption

Perhaps the most important thing we want redeeming LPs to be aware of is that redeeming typically triggers a state and federal tax both on: (a) the difference between their cost basis in the shares they exchanged into the fund (frequently this is their option exercise price) and the value given to the shares by Collective (i.e., the amount of their Collective starting capital account), and (b) any gain on the value of their Collective capital account since becoming an LP. These taxes are payable for the tax year in which the redemption takes place.

The exact calculation of the taxes triggered by redemption will vary based on a number of factors, including the LP’s state tax rate on capital gains. The following example is offered only for general illustrative purposes. Each LPs specific tax circumstances and calculations will differ materially. We strongly encourage all of our LPs to consult with their tax professionals for a detailed understanding of their specific tax consequences of redeeming their partnership interest.

Example

• John exercised 100,000 options with an exercise price of $1 each, establishing a $100,000 cost basis in the shares
• John exchanged those shares into the Collective Exchange Fund for a $500,000 limited partnership interest.
• John’s limited partnership interest has since increased in value; his capital account is now $600,000
• Now, John is thinking about redeeming and wants to calculate the taxes he’d have to pay if he does so.

Tax Calculation

• Capital gain on shares prior to exchange equals $400,000 (i.e. $500,000 - $100,000)
• Capital gain on LP interest equals $100,000 (i.e., $600,000 - $500,000)
• Federal tax rate on capital gain is 20% and 3.8% on net investment income so federal tax of $119,000 (i.e. 23.8% of $500,000)
• Assumed state tax rate on gain is 10% so state tax of $50,000 (i.e. 10% of $500,000)
• Total estimated tax triggered by redemption equals $169,000

Benefits of Not Redeeming

There are a number of potential benefits to not redeeming and instead becoming a long-term investor in the fund. First, the LP avoids the significant tax bill generally triggered by redeeming their partnership interest. Second, the LP’s tax savings from exchanging into the fund will continue to compound tax-free at long-term venture capital type rates of return. A third benefit is that the interest on any Exchange Loan may be claimed as a tax deduction each year the loan is outstanding.

For those who are able to leave their capital in the Exchange Fund for seven years, there is an even greater tax advantage. These LPs can redeem their fund interest for a portfolio of public securities without triggering any capital gains tax. This means that both the exchange into and exit out of the fund after seven years are tax-free. There are few wealth management strategies that can do as much to help create long term wealth.

Alternatives to Redemption

Some LPs are aware of the benefits of staying in the fund but feel they need to redeem, either to pay off a maturing Exchange Loan or because they need cash. We want to make LPs aware that they are generally able to refinance their maturing loans without redeeming. The new loan pays off the old Exchange Loan and, like the original Exchange Loan, is non-recourse. So, an LP never has to come out of pocket to repay it no matter what happens to the value of their fund interest. The refinancing does not trigger any taxes. LPs who are thinking about redeeming to generate cash for a purchase might instead consider an Exchange Loan instead. Unlike redeeming, the Exchange Loan is tax-free and lets your LP interest continue to compound in value over time.

Conclusion

At Collective, we know that making long-term investment decisions and minimizing taxes can be complex. We are here to help. If you have any remaining question, please feel free to speak to one of our friendly Customer Service Representatives to see how to get the most out of your Collective Exchange Fund Limited Partnership interest.

IMPORTANT DISCLOSURES

NOT AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY SECURITIES.

The information contained herein does not constitute a recommendation or advice by Collective Liquidity. You should consult your own tax, legal, accounting, financial or other advisers about the information discussed herein based on your specific risk profile and financial situation, including the suitability of an investment in the Fund, with Collective Liquidity, or any product offered or managed by Collective Liquidity.

Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

This information relating to the Collective Exchange Fund, LP (the “Fund”) has been prepared solely for informational purposes, is not complete, and does not contain certain material information about the Fund, including important disclosures and risk factors associated with an investment in the Fund, and is subject to change without notice. It does not constitute an offer to buy or sell an interest in the Fund, nor shall there be any sale of a security in any jurisdiction where such solicitation or sale would be unlawful.

The Fund’s limited partnership interest will not be registered with the U.S. Securities Exchange Commission or other regulatory authority. Investors will be required to verify their status as an “Accredited Investor” pursuant to Rule 501 of Regulation D to participate in any offering of the Fund’s limited partnership interests. No securities commission or regulatory authority has recommended or approved any investment or the accuracy or completeness of any of the information or materials provided by or through Collective Liquidity, Inc. or Collective Asset Management, LLC (collectively, “Collective Liquidity”).

Limited partnership interests in the Fund are not insured by the FDIC and are not deposits or other obligations of Collective Liquidity and are not guaranteed by Collective Liquidity. Limited partnership interests in the Fund are subject to investment risks, including possible loss of the principal invested.

Prospective investors should consider the investment objectives, risks, fees and expenses of the Fund carefully before investing in the Fund. This and other important information are contained in the Fund’s Confidential Private Placement Memorandum (“PPM”), which can be obtained by contacting Collective Liquidity.

Investment in the Fund involves substantial risk and any offering may only be made pursuant to the relevant PPM and the relevant subscription application, all of which must be read in their entirety. No offer to purchase securities will be made or accepted prior to receipt by the offeree of these documents and the completion of all appropriate documentation. The Fund intends to primarily invest in securities of private, late-stage, venture-backed growth companies. There are significant potential risks relating to investing in such securities. The Fund is not suitable for investors who cannot bear the risk of loss of all or part of their investment. The Fund is appropriate only for investors who can tolerate a high degree of risk and do not require a liquid investment. The Fund has no history of public trading and investors should not expect to sell limited partnership interests in the Fund. No secondary market exists for the Fund’s limited partnership interests, and none is expected to develop. The Fund has a limited operating history, and its performance is highly dependent upon the expertise and abilities of its manager. There is no assurance that the Fund’s investment objectives will be achieved, and results may vary substantially over time. This is not a complete enumeration of the Fund’s risks. Please read the Fund’s PPM for other risk factors related to the Fund.

^(*)All loans issued by WebBank, Member FDIC. Interests in the Collective Exchange Fund are not FDIC-insured and may lose value.