Your Company Is Going Public…Now What??

By Hightower Westchester on May 31, 2022

So, your company has decided to go with an Initial Public Offering (“IPO”). As exciting as that sounds, IPOs can also be overwhelming and require a bit of strategy to navigate all the potential implications. You and those around you will feel a sense of jubilation regarding this windfall, but it’s important to make the most of this opportunity as you only have one shot at it. There are several things to consider, whether it be tax implications, lock-up periods, estate planning and overall diversification worries, we’ll look to help you through this exciting but potentially stressful time.

First off, get organized! Download and review your stock plan documents and grant agreements. Understand what type(s) of equity compensation you are receiving, tax treatment/implications, key dates, strike price(s), vesting schedule, and so forth. You may be saying to yourself right now, even if I had these documents and information, I wouldn’t have a clue what to do with them! It’s ok, you are not the first and won’t be the last to have those worries.

Starting with the question we get the most, should I hold it or sell it? Generally, it’s a wise decision to diversify your assets or in other words, spread out your risk. When your company goes IPO, you may become a millionaire overnight and it is important to understand that those assets are directly tied to the ups and downs of a single company! I think a good question you should ask yourself is, what percent of your overall investment assets are tied up in the stock? As you know putting all your eggs in one basket can, at times, be a great way to become wealthy but it can also be a way to introduce greater risk and volatility to your portfolio and overall goals.

When thinking about selling your stock after the IPO, it’s natural for your first thought to be about missing out on future growth. Try to reframe the decision to sell so it’s to taking profits to reduce risk. Employees of pre-IPO or new public companies are often excited and bullish on the prospects of their employer. We have had clients who have a strong emotional tie to their company and others that are not currently employed with that company anymore and have no rooting interest. Investors tend to have stronger feelings when it comes to losses over the pleasure of gains, so I ask you to think about how you’d feel if the stock were cut in half vs. how you’d feel if the stock doubled in value? Or if you were given a cash bonus, would you use it to buy more company stock? It’s important not to let your emotions and love for your job, cloud investment judgement.

With many clients, we recommend selling a portion of their stock but not the entire allotment. This gives them the ability to lock in the gains from the IPO and still participate in any potential upside that may come. There is no exact amount or percentage we target as everyone’s circumstances are different. This is where we revert to your financial plan and goals to determine what amount makes the most sense.

Now that you have made the decision to take some action, there is this thing called the lock-up period. Most IPOs have a lock-up period that can typically last 90 to 180 days (3 to 6 months), during which shareholders are prohibited from selling their shares. Lockups can vary. There are times when 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. The lock-up period exists to make sure that the market isn’t flooded with too many shares all at once, which would cause the stock price to fall.

Once your lock-up period expires, don’t be surprised if the stock experiences a sharp decline as an increased supply of shares hit the market at the same time. Since this is common and a well-known phenomenon, many short sellers will be betting against the stock to make a quick buck, which in turn can drive the stock price even lower. With that said, this isn’t an exact science and sometimes stock prices go up once the lock-up period expires, which presents a marvelous trading opportunity for those looking to diversify. Be mindful of this dynamic when looking to transact.

Once you decide how much to diversify, the next step is to figure out how to make that happen in a way that minimizes your tax burden and maximizes your share price. Listen, we all hate paying taxes. So, what are some strategies to help reduce the tax impact of your company going IPO?

Let’s start with a Donor Advised Fund (“DAF”). A smart DAF strategy could have a large tax impact for those who are charitably inclined. For example, let’s say you plan to give away $8,000 each year for the rest of your life. If you have 30 years left, that’s $240,000. In the year that you exercise options or sell to diversify, you will likely incur one of the largest tax bills in your lifetime. Well guess what, wouldn’t it be awesome if you could aggregate all of your lifetime charitable deductions into that year? With a DAF you can! You’ll get the full deduction in that year (assuming it’s below 30% of your AGI), and you can leave the funds in the DAF account to invest and make gifts to charities when you feel comfortable.

The other beneficial aspect of a DAF is you can gift your appreciated stock directly into the fund and avoid the capital gains tax on the stock altogether. You get the charitable deduction on the gift and you avoid the capital gains tax on the stock that is gifted. Sign me up!

Another thing to keep in mind is the income breakpoint from the 15% to the 20% capital gains tax, which is currently $501,600 for a married couple filing jointly in 2022.¹ If you are planning to realize a significant amount, say, $800,000 or more of capital gains, it may make sense to straddle between two years to expose as much of the gain to the 15% bracket as possible.

As with any significant financial event, it’s crucial to have your estate plan reviewed. The amount the IPO will affect your estate plan will depend on how much your net worth has increased. The Federal Estate Tax Exemption is up to $12.06 million per person now, so most people won’t have to worry about estate taxes.²

Family gifting is another important consideration. You can’t gift your kids with unlimited stock to avoid the higher tax brackets because of kiddie tax rules. However, a minor can have up to $2,300 of unearned income tax-free.³ So one option that may make sense is to hold on to a portion of the appreciated stock you received to use as gifts for your family over the upcoming years.

If you have incentive stock options (“ISOs”) or non-qualified stock options, exercising your stock options in advance can create tax savings down the line. Companies that permit the grant of early exercise ISOs do so primarily to limit the impact of the alternative minimum tax (“AMT”) which places a floor on the percentage of taxes that a filer must pay to the government, no matter how many deductions or credits the filer may claim. However, due to counterintuitive tax regulations, structuring options in this fashion can expose one to negative tax consequences in the event of a disqualifying disposition. A disqualifying disposition refers to the sale of ISO shares within the same tax year as exercised, allowing you to pay ordinary income tax instead of AMT. ISOs qualify for favorable long-term capital gains tax treatment if held for at least two years from the grant date and one 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 one year after exercise.

In addition, if you have ISOs and trigger the AMT.  you’ll need cash to pay the AMT if you can’t sell your shares. 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, which will impact your cash flow.

The bottom line is that this is a highly nuanced situation when a company goes public. Often, the best strategy is to develop a plan to diversify over a set period of time. Think of it like dollar-cost averaging (an investment strategy in which an investor divides up the total amount to be invested across periodic purchases) in reverse. And plan for change. The IPO may not go as planned or it may not ‘go’ at all. Or the flip side, it could be wildly successful. Mentally prepare yourself for a rollercoaster. Only focus on what you can control. And understand your liquidity needs for other goals and taxes.

Before the IPO, get your advisory team together. Don’t choose the do-nothing strategy. 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.

Richard Flahive – Private Wealth Advisor and Director of Research & Planning – Hightower Westchester

914.825.8639 – rflahive@hightoweradvisors.com

Sources –

¹https://www.nerdwallet.com/article/taxes/capital-gains-tax-rates

²https://www.kiplinger.com/taxes/601639/estate-tax-exemption-2022#:~:text=2022%20Estate%20Tax%20Exemption&text=For%20people%20who%20pass%20away,combined%20exemption%20of%20%2424.12%20million.

³https://www.savingforcollege.com/article/what-is-the-kiddie-tax#:~:text=For%202022%2C%20the%20first%20%241%2C150,parent’s%20marginal%20income%20tax%20rate