How to Handle Post-IPO Equity

Advanced Financial Planning | High/Ultra High Net Worth | Wealth Management | Equity Compensation | Complex Financial Planning | Equity-Based Compensation | Long Term Investment Strategy | Equity Diversification | Incentive Stock Options | Post-IPO Equity | Stock Options

 Plancorp team By: Plancorp team

For years, investing in Silicon Valley was predominantly reserved for ultra-wealthy venture capitalists, but that exclusive landscape is changing. The last year has seen three massive initial public offerings (IPOs) from software vendor Snowflake (NYSE: SNOW), takeout delivery company DoorDash (NYSE: DASH), and hospitality platform Airbnb (NYSE: ABNB). Combined with all the other companies that have IPO'd recently, there are many people unsure what to do with their concentrated, post-IPO equity.

There is typically a 180-day lockup period before shares can be sold for insiders and employees of companies that have taken the traditional route to IPO. Once that limitation is lifted, the two primary concerns become tax and equity diversification — especially if a significant amount of your net worth is in your newly minted IPO employer. Let's take a look at two common scenarios you may experience.

Scenario A: Incentive Stock Options

Incentive stock options are one of the most tax-favorable types of equity compensation, but they are also one of the most complicated. For example, an employee begins working at a company in 2012 and is granted 100,00 shares of options with an exercise price of $0.10. The options vest over the next four years, and she receives a grant of an additional 100,000 options during that time with an exercise price of $0.50.

She exercises all her options as they vest, which means she now holds 200,000 shares of stock. The company IPOs in 2020 at $20 per share, and it's now trading at $100 per share five months later — meaning the value of her shares ($20,000,000) minus the price she paid ($60,000) has yielded a gain of $19,940,000. Even at the more favorable rate for long-term capital gains, selling all of her shares at once will come with an enormous tax burden, which is why I typically advise clients to diversify their post-IPO equity over a number of years.

Scenario B: Restricted Stock Units (RSUs)

Compared to incentive stock options, RSUs are a more straightforward form of equity compensation. However, employees owe income tax on the value of RSUs as they vest, and there isn't much they can control. If the RSUs vest on March 31st of each year, for example, and the employee has $100,000 of RSUs that vest, they'll owe $25,000 in income tax if they're in a 25% tax bracket. Companies are required to withhold 22% for income tax already, so the employee will only get $78,000 worth of stock and an additional $3,000 bill at tax time.

Employees at private companies can't sell their shares to pay the income tax when their RSUs vest, so these organizations generally include a clause with a second vesting requirement that says the company needs to IPO for shares to fully vest. RSUs become taxable when both vesting requirements are met.

Facebook (NYSE: FB) is a good example of a company that used a double-trigger RSU structure. The price of their shares continued to go up during the six-month lock-up period, and their employees had to pay income tax on the value of their shares when the lock-up ended.

Dropbox (NYSE: DBX), Lyft (NYSE: LYFT), Pinterest (NYSE: PINS), and others took a slightly different approach and used their double-trigger vesting with the date of the IPO. That decision allowed employees to pay tax on the value of their shares at the time the company IPO'ed, and the increase in their stock price during the lock-up period was taxed as capital gains.

The Equity Diversification Decision

Regardless of the type of post-IPO equity you received, the main question is whether you should diversify, how much, and how quickly. A key component of that decision is tax — but don't let tax be the only driver of your decision.

Whether you decide to sell, hold, or a combination of the two, you need a plan. Shares are going to vest, and taxes are going to be owed no matter what, and the sooner you can plan what you want to do with the shares the better prepared you will be. And if you're wondering how to reduce tax, early action is key as options and shares vest or stocks are sold.

Consider the following tips to make the most of your post-IPO equity:

  1. Understand the risk (and potential return) of a concentrated stock position. Are you willing to take the risk of a potential loss? What would your overall financial health look like if your stock suffered a catastrophic loss and didn't recover? Diversification can lower the risk of a major loss to your net worth by a single stock, but a concentrated stock position also comes with a potential upside if the stock outperforms the market. If this risk is one you're willing to take and you already have a diversified portfolio to balance a concentration in your employer stock, it could make sense to hold your position for the potential upside.
  1. Minimize taxes if you decide to diversify. It's critical to understand how the timing of exercise and sale of incentive stock options can impact your taxes, as well as RSU tax implications and other stock compensation. Minimizing taxes shouldn't be the only variable, but it's an important component of equity diversification. First, decide what you want out of your position, and then come up with strategies to achieve your goals with a minimal tax burden.
  1. Consider your short-term goals. Maybe you're still paying off student loan debt, you want to buy a first or second home, you'd like to time off from the grind of work, or you want to start a company of your own. All of these goals require capital. If you are letting your stock go untouched, what are you waiting for? Use some of it to meet these different goals. It's not uncommon to see people treat stock as a sacred holding that can't be sold, but it can and should be used to help you reach your goals than can lead a more fulfilling life. If you're already living your ideal life (or already have a diversified portfolio), a concentrated stock position on the side may just be the cherry on top.

These strategies are meant to help you utilize your post-IPO equity in a way that aligns with your goals. Whether you decide to hold a concentrated investment position, say goodbye to your single stock and fully diversify, or put yourself somewhere in between, thinking through the different components of the decision will help you make the most of the funds.

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Disclosure:

This material has been prepared for informational purposes only and should not be used as investment, tax, legal or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal and accounting advisors.

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