Your employer just had an Initial Public Offering (IPO). While you’ve worked there, you and your co-workers have been rewarded with stock and/or stock options, and you knew that there might be a big payday with an IPO. Now it’s happened — and you’ve got some big decisions to make. 

In this article, we hope to illustrate and guide employees who don’t know exactly what to do.

▶︎  Analyze Your Inventory

The first step as your company has its IPO is to understand your equity. Do you own nonqualified stock options (NSOs), incentive stock options (ISOs), restricted stock, and/or restricted stock units (RSUs)? You can find this information in your stock documents, grant summaries, stock option plan documents, and other relevant company correspondence.

This realm involves a lot of financial jargon, which we tried to simplify in this recent article: 

• • NSO, ISO, RSU, and ESPP: Equity Compensation Alphabet Soup

Also, what previous actions have you made? You’ll want to understand your previous activity so you can better grasp your cost-basis, historical exercises, and Alternative Minimum Tax (AMT) considerations.

Your company likely has an online portal where you can view your equity compensation in one place. If you’re unsure, you can always ask your colleagues or your human resources department where and how to access this information.

It’s important to note that many strategies exist for some types of equity compensation and not others. So going to your water cooler to hear how Mary from accounting dealt with her options may not apply to your situation.

• • For example, employees who receive restricted stock can make what’s known as a Section 83(b) election while employees who receive restricted stock units cannot use this strategy. This is why it’s important to analyze your inventory so you can see which strategies exist for your unique circumstance.

▶︎ Receiving Your Positions

For certain kinds of equity compensation, you must choose when and for how long you will actually own the stock.

• • This is true for both NSOs and ISOs. 

Pro Tip: If your employer’s plan allows, you may consider an early exercise of options before the IPO so you can start the clock on when you can qualify for tax-advantaged long-term capital gains.

After the IPO and lock-up period, you can also consider a cashless exercise so you can use the proceeds from selling stock to pay for the other stock. 

There are a few different strategies to consider when exercising stock options but the most favorable tax situations occur in these two scenarios:

1. Exercise your options to purchase the shares and then hold them without the intention to sell in the near future.

2. Sell the shares at least one year and a day after you exercised them, and at least two years since the original grant date.

a. This would be considered what’s known as a qualifying disposition.

Other types of equity compensation involve vesting schedules which detail when you’re awarded stock. The difference here is that instead of needing to purchase (aka exercise) your stock options, you’ll be rewarded stock per the vesting schedule.

• • This applies to restricted stock and RSUs.

When Can You Trade?
After an IPO, you probably will have restrictions on when you can trade your company stock. This is to prevent insider trading as well as employees flooding the market with the newly issued shares available on the public stock exchanges. When developing your strategy, you’ll want to become familiar with any timing restrictions.

Lock-up period: Your company may make an arrangement with the IPO-assisting investment bank called a “lock-up period.” During this period, employees can’t trade their positions. Lock-up periods tend to last around 3-6 months after the IPO, and any such timetable will be communicated to you through your company correspondence.

Trading Windows and Restrictions: Your human resources department will tell you if there are trading limits beyond the lock-up period as well. For example, some time periods are blocked leading up to quarterly earnings releases to prevent insider trading. These restrictions can also be called blackout periods and will be communicated to you through your plan documents provided by your company.

▶︎ Plan to Minimize Your Taxes

You made an effort to gather the information on what kind of equity compensation you own as well as what restrictions exist regarding when you can trade your company stock. Now, it’s time to focus on a controllable aspect of the IPO experience. 

One thing you can control during an IPO’s whirlwind: proactive tax planning.

Long-term Capital Gain Planning

As you can see in the chart below, you have some opportunities to maximize your financial net worth. This involves having patience and a plan to recognize long-term capital gains, even during the exciting IPO experience.

[vc_single_image image=”5572″ img_size=”full” qode_css_animation=””]Some other important tax situations and strategies occur when it comes to equity compensation. Before your company’s IPO, we strongly recommend you understand if these situations apply to your personal equity compensation scenario. This will have a tremendous influence on your upcoming decisions.

83(b) Election: This is relevant for employees who are granted restricted stock (note: these are not the same as restricted stock units). This election allows you to treat the grant of restricted stock as income in the year granted, not the year that it vests to you. There are special and detailed considerations that come with making an 83(b) election with a range of outcomes that can fall between substantial tax savings and paying tax on worthless stock.

Qualifying/Disqualifying Dispositions: If you plan to sell stock acquired and held through the exercise of ISOs, it’s important to note the potential tax outcomes.

Qualifying disposition: If you sell stock two years after you were granted the option, and at least one year after you exercised it, you will have a qualifying disposition. The difference between the sale price and exercise price will be taxed as a long-term capital gain.

Disqualifying disposition: If you sell your stock less than two years after you were granted the option or less than a year after exercise, you will have a disqualifying disposition. In this case, a portion of your earnings will be treated as W-2 compensation income (subject to income and payroll tax) and any gain will be treated as a short-term gain, subject to ordinary income tax. 

There are some scenarios where a disqualifying disposition is practical and even advisable.

Alternative Minimum Tax: Exercising ISOs can trigger alternative minimum tax (AMT). If it makes sense for you, you can time your exercises to minimize or even prevent some costly AMT miscues.

Net Investment Income Tax: This tax wrinkle that occurs in years when you have large amounts of investment income. We listed the thresholds in the chart above and if you meet those thresholds, you’ll have this tax added to either your short-term capital gains tax rate or your long-term capital gains tax rate.

Withholding Adjustments: When RSUs vest they are treated/taxed as a cash bonus. This means you can proactively prepare for the tax bill by changing your withholding status on Form W-4 to have more withheld from your paycheck if needed.

Gifting Shares: You can gift stock to your family, friends, and charities to alleviate some of your tax liabilities (but can also result in disqualifying dispositions of ISOs).

Pro Tip: You may want to hire help so you can create a personalized tax plan and equity compensation strategy. It really can get that complicated.

▶︎ Diversify Your Financial Success 

We sometimes notice clients who receive stock options, and other forms of equity compensation, begin to have top-heavy asset allocations. This means that the majority of a client’s financial net worth is tied to the company through their salary and equity.

Not all IPOs guarantee financial fortunes. According to Goldman Sachs analysts, “only 24% of companies that went public this year [2019] are set to report profitability before 2020.” And this was before the 2020 global pandemic. At the same time, unprofitable companies can also make people overnight millionaires as well. 

Overall, there’s a risk with every company’s future even if they look like they’re guaranteed to change the world. Scandals occur, markets change, competitors gain market share, laws change, and consumers want new things. We encourage you to let the company focus on these critical business decisions. Meanwhile, you can focus on your personal money decisions.

A good question to ask yourself once you receive a large amount of company stock:

• • If you received the value of that stock in cash, would you purchase your company stock in the same quantity that you own at that point?

If the answer is ‘no’, then this is when you need to make it a priority to diversify your investment portfolio.

Pro Tip: Diversify your assets so you don’t overly lean on your company’s financial success to take care of your personal financial success.

▶︎ Create and Follow the Plan

When things are calm, make a plan on what you want to do with your stock comp. Things can be a roller coaster leading up to, during, and after the IPO, and you will be limited to trade any of your company stock during the lock-up period. 

After the lock-up period ends, most trading restrictions are removed. We encourage you to develop a plan on what to do once you can sell your company stock. 

IPOs can be exciting and it can be a great time to celebrate with your work colleagues and your personal support systems. And don’t forget to treat yourself! Enjoy these times and we hope you feel more comfortable and confident with your stock options.