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IPO Financial Planning For Employee Stock Compensation

IPO Financial Planning For Employee Stock Compensation

| July 15, 2019

The people advisors meet at companies preparing for an initial public offering (IPO) are giddy with thoughts of the wealth and opportunities it will provide. Many of them have worked at these companies since the startup stage, and the IPO represents a long-awaited event that may be life-altering for both their company and them. I try to set them straight with five crucial points that may help to manage their expectations.

  1. Expect Volatility

Get ready for a roller-coaster ride! Your net worth may jump up and down by amounts greater than your annual salary as market volatility, beyond your control, whips the stock price back and forth.

Recent billion-dollar IPOs are examples of the big payoff that many startup companies' employees have dreamed of since they joined their companies amid the volatile markets of the past decade. However, I recommend to anyone who asks to prepare for unexpected twists—not every IPO company's stock price goes up. Recently, at several high-profile IPO companies, the stock price has fallen in the days following the initial pricing. Sometimes, there is what can only be described as hysteria, causing the price to first jump only to fall, sometimes just days or weeks later. That behavior is why you should not have unrealistic expectations for your company's just never know.

With your IPO company's stock price, you want to hope for the best but plan for the worst—especially considering the price has been bid up by venture capitalists ahead of the IPO. Don't assume further appreciation, and prepare for the possibility of a decline.

  1. Respect Diversification

At new publicly traded companies, many of the employees are young. This is very likely to be their first experience with real wealth. Like professional athletes or lottery-winners, these young people have what looks like a substantial net worth, and yet their income and net worth are tied to their companies' value in a competitive world economy where fortunes can come and go quickly. Frequently, people who work for a company that goes public do not know how to handle the windfall of sudden wealth and make poor financial decisions. Because they are passionately loyal to their companies, these investors may resist suggestions to diversify their holdings. Often the corporate culture reinforces this attitude. There is no lack of confidence for the future at a successful startup.

Remember that your income is already tied 100% to the company. To achieve balance in your net worth, get ready to sell shares according to a systematic plan and invest in diverse assets. I encourage IPO employees to diversify their wealth holdings by selling some shares when they can and investing those amounts in other assets. Have a systematic approach to moving some net worth into other assets. A sales plan under SEC Rule 10b5-1, managed through an experienced equity compensation financial planner, is the recommended method for this approach.

  1. Get Real About Your Wealth

Be serious about this new-found wealth. It's no longer pie-in-the-sky money. It is real and should be responsibly managed well into the future.

What we often see is that people who are very closely involved with a relatively young company believe their company is the greatest investment in the world. (Why wouldn't they? It just made them rich.) But a naive employee with new wealth is likely to be contacted by many stockbrokers, financial advisors, and wealth advisors—each with their own idea of what the employee should be doing with the money. That doesn't always work out for the inexperienced investor.

For some newly enriched employees in hotbed IPO country, like the San Francisco area, financial planning and/or diversification may mean moving into an alternative and equally volatile asset class for the first time: real estate. The fact that new wealth will allow you to buy a big house doesn't mean you should do so. If we learned anything from the credit crunch of 2008, it is that home prices don't always go up—and the most expensive homes are the most vulnerable to wide price fluctuations.

  1. Live With Restrictions From The Underwriter And The SEC

The restrictions of the lockup will keep you from doing anything with your shares for (usually) 180 days after the IPO date, even if you have exercised options or hold restricted stock that vested before then. Executives must follow additional restrictions and rules even after the lockup period. Don't make the mistake of judging stock values according to the price on the day of the IPO. The price at liquidity, when shares are no longer locked up, may be very different. I recommend waiting to exercise any stock options until after the lockup.

Whatever you do, your individual circumstances, including the rules of the company you work for, dictate your strategy. Be careful. Newly public companies may not have fully developed insider-trading policies. They may not have procedures in place to help prevent inadvertent violations of SEC rules. Even in the absence of these in-house rules, each stockholder is responsible for following the law. The potential consequences that await violators include fines several times greater than the proceeds of the transaction that led to the violation.

  1. Understand Taxes

Taxes are a potential minefield for the newly wealthy. If part of your equity compensation package includes incentive stock options (ISOs), in addition to founder's shares, non-qualified options (NQSOs), or any of the myriad of other forms of stock-based pay discussed on this website, tread lightly before you begin to exercise or sell. Make sure your advisor has experience in managing multiple forms of stock compensation simultaneously so that you get the chance to deploy a sound tactical disposition plan. For example, exercising stock options during a lockup does not delay the related taxes until the lockup is over and you can sell the shares—a common misunderstanding among my clients. The taxes are due at the time of exercise—creating the possibility of a cash crunch when the employee is asked to come up with the payment for tax withholding and yet cannot sell shares to cover the taxes.

Taxes create an even greater dilemma while your company is private and resale opportunities are limited or nonexistent. I am not a big fan of exercising options before your company goes public, given the risk that it may never go public or be acquired. You want to consider the tax consequences of exercising ISOs before the IPO and holding the shares to get all capital gains on the eventual sale. If the price of your stock crashes but you have already triggered the alternative minimum tax on your paper gains, you can find yourself selling low-priced shares that may not even cover the tax bill you incurred at exercise. This risk is even greater with NQSOs, as you will also trigger tax at exercise on the spread. You also want to involve an experienced estate-planning lawyer, as there are various strategies to consider by employing the use of trusts and with gifting or donating stock, which can be put in place when your stock price is low, long before the IPO.

All investing involves risk, including the possible loss of principal.  There is no assurance that any investment strategy will be successful. Investors should consider their financial ability to continue to purchase through periods of low price levels. The return and principal value of stocks fluctuate with changes in market conditions. Shares when sold may be worth more or less than their original cost.  A diversified portfolio does not assure a profit or protect against loss in a declining market.

This blog  is designed to provide accurate and authoritative information on the subjects covered. It is not, however, intended to provide specific legal, tax, or other professional advice. For specific professional assistance, the services of an appropriate professional should be sought.