Preparing Financially for an Employer’s IPO: A Guide for Employees with Equity Compensation

For employees with equity compensation, the announcement of an employer’s Initial Public Offering (IPO) can be both exhilarating and daunting.

If you’re fortunate, an IPO can significantly improve your financial circumstances and trajectory, setting you on a path to financial independence. However, an IPO can also result in complex tax and legal issues if you don’t plan effectively.

Thus, it’s crucial to consider all the potential benefits and risks within the context of your financial plan and goals, so you can avoid costly missteps and maximize your windfall.

These 5 steps can help you prepare financially for an employer’s IPO:

#1: Understand Your Equity Compensation

As an employee with equity compensation, you have the unique opportunity to participate in your company’s future growth and financial success. However, the world of equity compensation can be complex. To navigate it effectively, it’s important to thoroughly understand its nuances.

If your employer announces plans to go public, a solid understanding of your equity compensation can help you determine your next steps. In most cases, your equity compensation will fall into one of two broad categories:

• Stock Options. Incentive stock options (ISOs) and non-qualified stock options (NQSOs) give employees the right to buy company stock at a predetermined price (the “strike” or “exercise” price) after a certain period. If the company’s stock price rises above the strike price, stock options can offer substantial upside potential. However, stock options can also expire worthless if the stock price remains below the strike price.
• Restricted Stock Units. Restricted stock units are company shares that an employer promises an employee. However, the employee doesn’t own the shares until they vest. Once the shares vest, the employee is free to hold or sell them.

Be sure to familiarize yourself with your equity compensation agreement, particularly your vesting schedule, exercise terms, and expiration dates. Armed with this information, you can begin to prepare financially for an employer’s IPO.

#2: Consider the Potential Tax Consequences

It’s also essential to understand the potential tax implications of your equity compensation. By educating yourself on the various taxes your equity and timing decisions may trigger, you can craft a strategy to maximize your net payout.

Incentive Stock Options (ISOs)

Typically, you owe no tax when you exercise ISOs. However, the difference between the exercise price and the stock’s fair market value may be subject to Alternative Minimum Tax (AMT). When you sell, you may owe capital gains taxes on the difference between the sale price and the exercise price.

Non-Qualified Stock Options (NQSOs)

When you exercise NQSOs, the difference between the exercise price and the stock’s fair market value is subject to ordinary income tax rates. When you sell, you may owe capital gains taxes on the difference between the sale price and the exercise price.

Restricted Stock Units (RSUs)

When RSUs vest, the fair market value of the shares is subject to ordinary income tax rates. When you sell, you may owe capital gains taxes on the difference between the sale price and the share price at vesting.

Timing Matters

Indeed, the timing of when you exercise stock options or when your RSUs vest—as well as when you sell them—can significantly affect how much you owe Uncle Sam.

For instance, exercising stock options when the stock price is low can minimize the amount of income you must recognize on your tax return. Meanwhile, selling shares in a year when your income is below average may result in a lower tax bill.

In addition, waiting at least a year after you exercise your options or your RSUs vest to sell your shares lowers the capital gains tax rate on any appreciation to 0%, 15%, or 20% depending on your taxable income. If you sell your shares within the first year, any capital gains will be subject to your ordinary income tax rate.

Also, keep in mind higher-income individuals may be subject to the Net Investment Income Tax (NIIT), an additional 3.8% tax on investment income. Moreover, it’s important to consider potential state and local taxes, as these can vary significantly and add to your tax bill.

Finally, it’s important to note that if you plan on exercising stock options, you must have enough cash on hand to cover the purchase and any associated taxes. With RSUs, you’ll need enough cash to cover the tax bill when they vest or your company may withhold the taxes from the vested shares. Depending on how you come up with the cash—for example, you may decide to sell other investments—there may be additional tax consequences or penalties.

Given the complexities, it’s often beneficial to engage in tax planning strategies, such as spreading out the exercise of options over multiple years, leveraging tax-efficient accounts, or considering charitable giving to offset your tax bill. At SageMint Wealth, we can help you design a tax-smart plan that minimizes your potential tax burden.

#3: Be Aware of the Lock-Up Period

The lock-up period is a predetermined span post-IPO (typically 180 days) during which insiders, including employees, early investors, and executives, are prohibited from selling shares.

This restriction aims to keep the company’s stock price relatively stable by preventing a massive sell-off of shares immediately following an IPO. It also signals to the market that insiders have faith in the company’s long-term prospects, which can foster investor confidence.

Knowing the exact date that your shares become liquid can help you prepare both mentally and financially for an employer’s IPO. Being aware of this timeline can also help you determine next steps once the lock-up period ends.

For example, your inclination may be to sell your shares immediately after the lock-up expiration date—especially if you see an opportunity to lock in a gain. However, keep in mind you may be subject to higher taxes on capital gains if you hold your shares for less than a year after you exercise your options or your RSUs vest.

Alternatively, a significant portion of your net worth may be tied up in company stock following a successful IPO. Therefore, the end of the lock-up period may be a good time to consider diversifying your portfolio in alignment with your financial goals, tax objectives, and risk tolerance.

Lastly, as you prepare financially for a potential IPO, keep a close eye on company performance, industry trends, and market sentiment. This knowledge can help you make an informed decision about holding or selling your shares post-lockup.

#4: Plan for a Significant Liquidity Event

In some cases, selling shares after a successful IPO can result in a significant influx of cash. While sudden wealth can be exciting, it can also cause anxiety and overwhelm if you don’t have a sound financial plan in place.

For instance, sudden wealth can introduce unexpected expenses or temptations to make impulsive purchases and investments. Strategic planning can help counteract these temptations, so that rash decisions and lifestyle inflation don’t keep you from building wealth.

Meanwhile, prioritizing your financial goals can help you make the most of your windfall, whether you dream of buying a home, funding your children’s education, or retiring ahead of schedule. On the other hand, you may want to use this opportunity to shore up your finances by paying off outstanding debts and establishing an emergency fund.

Additionally, keep in mind that your newfound wealth may require advanced financial planning, including a well-defined investment strategy, comprehensive tax and estate planning, and asset protection strategies. By assembling a team of experts to help you manage your money, you can elevate your current financial status while strategically working toward longer-term goals and aspirations.

#5: Assemble Your Team of Advisors

Navigating the complexities of an IPO and its aftermath can be difficult without the right team of experts guiding you. A fiduciary financial planner like SageMint Wealth, as well as an experienced estate planning attorney and tax advisor, can help you make the most of this unique opportunity by helping you understand the nuances of your equity compensation and make decisions that align with your financial needs and objectives.

SageMint Wealth is a wealth management firm for high-net-worth individuals, families, and business owners that’s committed to growing wealth and investing in a better world. Whether your net worth is steadily rising, or you expect an influx of cash due to an IPO or other windfall, we can help you develop a comprehensive financial plan to grow your wealth and preserve it for generations to come.

To learn more about how we help our clients protect their hard-earned wealth and achieve their financial goals, please contact us. We’d love to hear from you.