What does an IPO mean for employees? And what should you do when your company is about to go public? For early-stage employees and executives with stock, a company going public can potentially be life-changing. For workers hired closer to the IPO, there’s still potential for some type of windfall. If you don’t have stock options or equity awards at all, going public will likely just be business as usual. For employees with stock, here’s what to do when your company goes public.
What does an IPO mean for early employees?
An IPO provides liquidity for the company. It’s also an exit strategy for founders/investors and a way for employees to sell stock too. It’s much harder for employees of private companies to sell their shares and it’s not always possible.
Working for a company before it goes public can be highly beneficial for employees who have stock options or RSUs. When employees are given stock options at an early-stage startup, they usually have the right to buy shares at a very low valuation. How low? Often, less than $1.
Here’s a simple example:
- Lifetime options granted: 200,000
- Average strike price: $1.15
- Total cost to buy options: $230,000
- IPO price: $20
- Potential pre-tax proceeds: $3,770,000
Whether you’re a one-time or serial startup employee, there’s a serious potential for net wealth accumulation. Of course, there are many other variables at play which will help determine what an IPO might mean for you financially. Factors such as taxes, how long you own the stock, post-IPO performance, etc., will all play a role. More on this to follow below.
4 tips on what to do when your company goes public if you have stock options
If you work for a company that has gone public (or is about to), or if you own stock from a previous employer in the same situation, you likely have questions about what to do with your shares or what happens to stock options after an IPO. Here are some of the things to consider when your company moves from the private market to the public one.
1. Get organized!
Download and review your stock plan documents and grant agreements. Understand what type(s) of equity compensation you have, the tax treatment, key dates, strike price(s), vesting status, and so forth. Getting a team of advisors (financial, tax, estate) together to assist you is highly recommended if you’re expecting life-changing sudden wealth.
For early employees, founders, and individuals who acquired their stock years ago, consider whether you might qualify for the tax-free sale of qualified small business stock on all, or a portion of, your shares. Isolate those!
2. Find out when you can sell
If you’re a current employee, the company has likely communicated with employees (in clear terms) about the lockup period, should one apply (as is common). If you’re a former employee, this may be a bit harder. In a typical IPO, the underwriter may require that the lockup extends to former employees.
The company may send you a letter or you may need to reach out and/or sift through SEC filings. In SPAC deals, the business combination agreement will have details about the lockup, but again, you’ll need to figure out what applies to you. Lockups can vary: sometimes it’s a stated number of days, event based (such as reaching a target share price or an earnings release), a combination of the two, or a multi-stage release. The terms of the lockup can also change before or after the company goes public!
3. Expect a lot of ups and downs
The IPO may not go as planned. It may not ‘go’ at all. Or perhaps it’s wildly successful. Mentally prepare yourself for a rollercoaster, especially during a lockup when unable to hedge or sell any shares. Focus on what you can control. And be very careful not to pre-spend the proceeds. Bottom line: it’s a highly nuanced situation when a company goes public.
4. Use the lockup period to get everything in place
There’s a lot you can do during the lockup period to set things up for when the shares are released. For example, you’ll want to consider when to exercise vested stock options, quantify and prioritize new/existing financial goals, consider diversification and sales targets (as a percentage of your current holdings and a dollar amount), and understand your liquidity needs for these goals, any major purchases/expenses, and taxes.
Also use this time to get things set up logistically. When the shares are eligible for transfer, you’ll want to have a brokerage account open. Not all transfer agents facilitate stock sales, and even if they do, you might not want to just dump X shares in a blanket market order. Find out what you can and can’t do at the transfer agent, if the current transfer agent is changing around the IPO, and the process to move shares when they’re released. Ask about tax lots, especially if you have qualified small business stock.
Get your professional team in place, including a financial advisor who specializes in stock options and sudden wealth, estate planning attorney, and CPA. These advisors can’t provide personal advice and support until formally engaged and they get an understanding of your financial situation and goals. That all takes time, potentially months. This might be the only time you experience a major liquidity event, so you don’t want to be making big decisions blindly or at the last minute.
More on the various considerations to get everything in place below.
Developing your exercise strategy
If you have incentive stock options or non-qualified stock options, exercising your stock options in advance can create tax savings down the line. ISOs qualify for favorable long-term capital gains tax treatment if held for at least 2 years from the grant date and 1 year from the exercise date. Non-qualified stock options are taxed at exercise and any subsequent gain can qualify for long-term capital gains if held for 1 year after exercise. Here’s more on how stock options are taxed.
Strategic tax and financial planning before deciding when to exercise stock options
You’ll need to consider several trade-offs and considerations:
- If you have incentive stock options, exercising may trigger the alternative minimum tax. This isn’t the end of the world, but you’ll need outside cash to pay the AMT if you can’t sell your shares so consider the timing carefully as the lockup will typically last 180 days. You’ll also need funds to buy the shares at exercise. Consider the pros and cons of a net or cashless exercise after the company goes public.
- If you have non-qualified stock options, consider the cash flow implications. Weigh the pros and cons of paying for the stock out of pocket versus a cashless or net exercise after the IPO. And be aware that at exercise, your employer should withhold a portion of pay for taxes (either 22% or 37% until 2026 when set to increase), which will impact your cash flow if retaining the shares. With any type of equity, exercising right before an IPO can be a risky strategy due to valuations, lockups, and potential tax liability.
- Due to the tax treatment of stock options, exercising early can provide big tax savings down the road. If the anticipated IPO is still a ways off, consider early exercising stock options. When you exercise and hold stock options, there are risks. If the post-IPO stock price sinks below your strike price, you’re underwater. This risk becomes greater for employees who receive grants closer to the IPO as the valuation of the company should be much closer to the target IPO price than early-stage employees.
- Also realize that while an IPO may seem imminent, things can always change. WeWork was on the cusp of a massive initial public offering in 2019 before it was suddenly halted. WeWork went public via SPAC merger in October 2021, though the valuation was significantly less. (August 2023 – WeWork is now teetering on bankruptcy)
- In some situations, it may not make sense to exercise your options until after the IPO and lockup release. That way, there’s no risk of becoming underwater or losing the public market for your shares, as you can simultaneously exercise and sell the options at once. It can also help you avoid having already exercised shares go underwater during a lockup.
Before the IPO, get your advisory team together. Consider working with a financial advisor and CPA to develop an exercise strategy that’s aligned with your entire financial situation. You’ll need to have the right team in place post-IPO to manage your shares from a diversification, risk, and tax perspective as well.
Video: What to do with stock options and restricted stock before an IPO
Deciding when (and how) to sell and take profits
When thinking about selling your stock after the IPO, your first thought might be fear of missing out (FOMO) on future growth. Instead, try to reframe the decision to taking profits in an effort to reduce risk.
Employees of pre-IPO or newly minted public companies are often very bullish on the prospects of their employer. But it’s important not to let emotional attachment cloud investment judgement. Shareholders of publicly traded companies might not be as forgiving if profit goals are missed.
When considering whether to hold or sell your stock after the lockup period, it’s important to try and strike a balance between turning paper profits into realized gains and participating in possible future upside. If you were given a cash bonus, would you use it to buy more company stock?
Developing and executing an exit strategy
Sometimes, even executives who want to sell their stock have hurdles in doing so. After an IPO, we work to help clients develop and execute a sales plan after the lockup.
Here are examples of planning items we may be able to assist with depending on whether the client is a current or former employee:
- Stock price targets
- Evaluating limit vs market orders
- Buying or writing call/put options
- Target proceeds (annual or cumulative)
- Financial goal-based projections and funding recommendations
- Addressing liquidity issues if the stock is thinly traded
- Specifying liquidation order based on holding period, tax cost basis, AMT credits, qualified small business stock (Section 1202) eligibility, and other factors
- Many other considerations such as cash needs, risk tolerance, general outlook for the company, and so on
Financial advisor for stock options and sudden wealth
Darrow Wealth Management specializes in stock options and equity compensation. If your employer is going public, work with an advisor experienced with strategic stock option planning, tax implications, and strategies to best manage sudden wealth. You only get one shot at this.
Here are some of the ways we work to help executives, founders, and employees navigate an IPO:
- Exercise strategies
- Trading plan and execution
- Assist with identifying and tracking shares likely to qualify for the tax-free sale of qualified small business stock
- Decide on a strategy to best use the proceeds, including funding multiple goals and investment management services to help you diversify sudden wealth
- Incorporating the proceeds from a major liquidity event into your financial goals and projections
- 10b5-1 plan provisions
Nationally Recognized Wealth Advisor in Stock Compensation
Kristin McKenna CFP® is a nationally recognized specialist in employee stock options and equity compensation.
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