Nobody tells you THIS when your company IPOs
An IPO has the potential to be the most life-changing day—completely reshaping your life's trajectory. Going public is romanticized because the stakes are highest and the lights are brightest…but it might not actually make you rich. The only certainty with IPOs is uncertainty.
This is me at one of the world's largest stock exchanges—where companies come to go public…Also known as IPO.
An IPO is like a wedding day. There are high expectations, lots of uncertainty, and depending on who you marry, you could become very wealthy. An IPO has the potential to be the most life-changing day, completely reshaping your life's trajectory. It’s one of the most coveted locations for startup founders and employees as generational wealth is often realized right here. Going public is romanticized, the stakes are highest, the lights are brightest…but it might not actually make you rich. The only certainty with IPOs is uncertainty.
“The only certainty with an IPOs is uncertainty.”
But how do you even prepare for this potential windfall? There are potentially life-altering decisions: When should you exercise? When should you sell? Maybe you have stock options or RSUs. Today I’m going to be covering your BIGGEST QUESTIONS about what actually happens in an IPO, what they don’t tell you about your equity, and how to prepare for and make the most of your IPO—whether you’re an executive or an employee.
Let’s quickly divide this into 3 periods: Pre-IPO, IPO, and Post-IPO. Each time-frame, I’ll address the most important thing…How this affects you and what to do about it, but you need to understand the context, so I’ll address what’s happening in the company. But first, what is an IPO?
Stage 1: Pre-IPO
Inside the Company
An Initial Public Offering, is where a company is first traded on the public market. If your company is PRE-IPO, that means that your company stock isn’t publicly traded currently. Going public (or even a M&A) is something that many large private companies build a clear path towards—an ultimate exit and a bright future. The best candidates for IPOs are typically late stage companies that have already raised several rounds of funding from VC firms. While certainly not a requirement, it is a common occurrence. They often raise as much as 3 rounds to a Series C before going public. Some companies even raise all the way through a Series G before IPO-ing.
There’s also a timing element when companies decide to go public. Companies will often wait til the market is healthy and investor optimism is high to get the highest valuation possible. When the time is right, they’ll make the decision to go public. Companies will want to be valued higher at the IPO than its most recent valuation—so that the most recent investors are turning a profit. Until the likelihood is high to be valued higher, the company will most likely remain private.
Know that this isn’t a whimsical last minute decision, but something companies spend several months or longer preparing for the rigors of becoming publicly traded. Even if the underwriting process has begun, market changes could cause delays.
But how does this affect you as an individual?
Personal Impact
What to do while your company is Pre-IPO
Up to this point, you probably haven’t had much control of the company, if any. This is where your life-altering decisions begin as we address what’s actually in your control. Whether you have stock options or RSUs, you need to start by creating a plan. It is essential. If there’s one thing you get from this article it’s this…Hope for the best, plan for the worst. Here’s the financial framework that I created to help you make any financial decision, and it’s especially true for IPOs.
1. Values and Goals. The purpose of your life isn’t just to create the largest bank account possible. If you’re trying to make the most money possible in the IPO, you’ll probably take on too much risk and end up losing money. Set the company Kool-Aid down for a minute and get as objective as possible. Quit daydreaming about the eye-popping amount of money and get serious about what you really truly value. What are you really working towards in life? Realistically, you are probably working towards something like a down payment for a house, funding an education, or some international travel. Take note of any large future expenses in the next 3-5 years. If you don’t have any goal, now’s probably the time to give some direction to your money. The IPO will be an emotional event, and that’s okay. Let’s plan in advance so we can be prudent when our emotions are highest. Ultimately, we don’t want our temporary emotions calling the shots as the volatile stock market thrashes the company stock price up and down.
To manage expectations, just know that you’re likely to build generational wealth if: you're a top 5 employee, a founder, company raises little capital, you become an executive at the right time, and/or the company is valued at +$10 billion.
2. Risk Tolerance and Capacity. As someone who worked with tons of employees at a variety of tech companies…If I had a dollar for every company that said it has the intention of IPO-ing within 3-5 years…Well, I wouldn't be writing this article. Please don’t put your whole financial future on the success of your company. Don’t expect the IPO to solve all of your financial problems. While your company is Pre-IPO, take steps to get your finances in order. Please build up an emergency fund, start funding your retirement, and be careful with debt. You’re welcome to drink the company Kool-Aid, but please cover your financial basis outside of work so that you’re not completely dependent on the success of the company.
When a private company is eyeing an IPO, please remember that there’s no guarantee that it’ll actually happen. Working for a startup is all about the chance of getting paid-out later—and there’s risk in that. This risk will affect decisions surrounding your equity.
If you have stock options, you're probably wondering if you should exercise. When you exercise, you’re locking your money up in company stock and are likely triggering taxes (depending on several factors). Can you financially and emotionally afford to lock up that much money in company stock and taxes? Remember there is no guarantee that the company will IPO or be purchased. The result is mostly out of your control.
If you’re close to the IPO, then it’d be prudent to wait to exercise because of the uncertainty. But ultimately, it depends on exercise costs, tax ramifications, and your personal financial situation. Your strike/exercise price won’t change during the IPO, but the fair market value will. A lot of people romanticize sophisticated tax strategies, and take on unnecessary risk to optimize something that shouldn’t be a top priority—taxes. I’ve seen people destroy their financial life trying to optimize their post-tax payout. The last thing you’d want is to take on a large tax bill before the stock price drops. Nobody knows what’s going to happen and no one is removed from the volatility of the stock—even the founders. You need to be smart and flexible.
Ask yourself: Am I willing and able to take on this risk? Said differently, are you financially and emotionally able to take on this risk? Your emotional willingness is known as risk tolerance. Would a therapist say that you could emotionally afford to see your net worth be thrashed around up AND down? Would you sleep well at night? Would the risk cause you to become irritable and treat others differently? Your financial ability to take on this risk is known as risk capacity. As a financial planner, when I look at your finances, would you be able to afford this financially? Elon musk, can afford to lose $10 billion dollars. On the other hand, can you afford to lose a billion dollars? No, you can’t. The risk of exercising wouldn’t be bad if you could just sell your stock to cover the costs, but there’s one thing that Pre-IPO companies lack—liquidity. The lack of liquidity really heightens the risk. If your company is still a bit away from an IPO, liquidity will be rare. There may be an occasional tender offer or secondary, but it probably won’t be happening super close to the IPO as that would be a little redundant to be raising money right before an IPO.
If you have restricted stock units (RSUs), then you’ll likely have to wait for the IPO as your RSU probably has a double trigger vesting schedule—dependent upon some sort of liquidity event such as IPO.
3. Financial Merit & Taxes. Understanding your equity is a great place to start for the next step—strategizing. Do you have RSUs? ISOs? Are they vested? Does your equity have a double trigger, or a single trigger? You’ll want to read through your grant documents and your company’s equity plan as this will help you understand what you have and the restrictions.
I would be running tax and financial projections, understanding if you have the resources and risk tolerance to exercise. Avoid complicated hypotheticals. When planning, I like to keep it simple and run 3 projections. Go to both extremes (best case scenario, worst case scenario, and something in the middle that’s more likely going to happen). This will help prevent you from anchoring to some unrealistic expectation.
While the company is private, it may be a great time to exercise company stock while it’s cheap and before any serious appreciation happens in the stock’s value. When the stock price is low, there’s little spread to be taxed and you could potentially avoid AMT (if applicable).
In order to strategize, you’ll need the right professionals in your corner to help you. Coordinating complicated financial, tax, and estate strategies requires a level of sophistication you can’t learn in a blog post or two. Please don’t rely on your co-workers at the water cooler. Sudden wealth requires more than just knowing what a Roth IRA is.
If you’re an early employee, pre-IPO can be a great time to do estate planning. One strategy that an attorney can help with is creating a trust for tax stacking—which is a tax planning strategy specific to qualified small business stock (QSBS). Eventually, you may need a Securities Attorney for creating a 10b5-1 trading plan—which is mostly for executives.
A good CPA can help you file the taxes and tell you how much you owe. The problem with that is that it’s re-active, not proactive. A good financial planner who specializes in equity compensation can even help minimize your tax bill through proactive tax planning and help you diversify your investments. That’s why I created my wealth management firm to do proactive tax and financial planning for owners of equity compensation (ISO, RSUs, etc.) to ensure you optimize your equity and minimize your taxes no matter your situation—pre-IPO, IPO, post-IPO.
Tax-Efficient Diversification
Okay, now that we know what to do pre-IPO, let’s talk about the actual IPO.
Stage 2: IPO
Inside the Company
This is the IPO paperwork, known formally as the S-1. If the IPO is the wedding, then the S-1 is the engagement. The S-1 really kicks off the IPO process—the catalyst if you will. I’ve also heard the S-1 being the center of the IPO solar system and everything revolves around it. When a company files their S-1 this signals to the public and investors that the company is actively pursuing an IPO. But, just like wedding engagements can be broken off before the wedding, there's no guarantee that this S-1 filing will in fact, lead to an IPO. It’s only a moderate indicator of an IPO around the corner.
The S-1 is hundreds of pages explaining the company’s history, its executives, the financials, and perhaps most importantly, the risks associated with the investment. To a certain extent, it is like a pitch to prospective investors. This will be filed with the help of an underwriter for example, Morgan Stanley, Goldman Sachs, etc. The underwriters help guide a company through the IPO process (just as a father would escort the bride down the aisle). Just like weddings have to be officiated by clergy or certified officials, the Securities and Exchange Commission (SEC), officiates this wedding between a private company and the market.
The S-1 won’t actually tell us when the IPO will happen. You’ll likely only learn about the actual date of the IPO only a few days before it happens. But can the S-1 filing give us any insight into when the actual IPO will happen? Not exactly, The time between the S-1 and the actual IPO of the company can vary based on several factors: SEC feedback (“SEC Comment Letter”), market conditions, financial performance, regulatory challenges, etc. Ultimately, there are no set timeframes here. It usually takes a month for the SEC to review the initial S-1, but the may request changes to be made before approval. Filing these amendments ("S-1/A" or "S-1 Amendment") can take time. Once approved by the SEC, then the company will try attracting investors by going on a roadshow to market the company stock, which can take a week or two.
There’s one more thing that companies will do before actually going public. Once the effectiveness of the S-1 takes place, the company is going to make changes to their equity compensation, by filing an S-8 with the SEC. Companies often do a complete restructure of their equity plan to become more competitive in the public markets. In private companies, executives are often concerned about the private investors who fund their company, whereas public companies are more concerned about the creation of shareholder value. Private investors and shareholders each have very different expectations around executive pay programs and equity. Therefore companies often do a complete refresh of their equity plan before IPO-ing. It’s also easier for companies to get their new equity plan approved from shareholders while private versus being public. While the equity grants are incentivized to retain key executives and employees, just know that the future grant may not be similar to your previous grants…for better or worse. The grant will be based on a combination of other peer companies and recent IPOs.
This has all led up to the big day—the Initial Public Offering. The market exchange your company will be listed on—oftentimes at the NASDAQ or the New York Stock Exchange (NYSE)—will invite the founders, executives, underwriters, or other key shareholders to the ceremonial ringing of the opening bell. The company is officially public!
But what does this all mean for you?
Personal Impact
What to do while your company IPOs
First let’s take a step back to when the S-1 is filed, as that’s the catalyst to your company actually going public. When the S-1 is filed, it’s public information so you’ll know your company is serious about going public. What should you do once the S-1 is filed?
If you’re an executive, the filing of the S-1 begins a timer for the company’s management team where they aren’t allowed to express any opinion on the value of the company—This is known as the Quiet Period. This period starts from the filing of the S-1 (registration statement) until 40 days after it debuts on the market (goes public). You may also need to create a 10b5-1 Trading Plan—which protects you from insider trading accusations. The main rule of setting up a 10b5-1 trading plan is that you can’t have non-public insider information at the time of creation. There is so much disclosed during this period that it can often be a great time to establish a 10b5-1 trading plan.
But let’s talk about your equity. If you’re able to exercise your stock options, I’d seriously contemplate waiting. When your company IPOs, it’s unlikely you’ll be able to sell your stock. Waiting would be prudent here until you’re able to actually sell your stock.
“...tax rules don’t change surrounding your equity because of an IPO.”
Something to note is that the tax rules don’t change surrounding your equity just because of an IPO. RSUs still have OI upon vest, and stock options will have to report the spread on exercise as either OI, or as an AMT adjustment. Unfortunately, you probably won’t be able to sell the shares to cover taxes for 6 months. You’ll also likely owe quarterly estimated taxes before the April 15th tax deadline. This can be bad news for owners of RSUs because your RSUs will likely vest upon IPO. RSUs typically have a double trigger—the first one being the length of employment, and the second is likely a liquidity event (like an IPO). When RSUs vest, you’ll owe taxes on the gain. So there’s potential to owe a large tax bill without the ability to pay it…Or even worse, you could owe a large tax bill on worthless shares. This is why I’d strongly consider waiting to exercise until you can sell your stock to cover the tax bill.
Once your company goes public, brace yourself for uncertainty. A recent NASDAQ study of companies that IPO over the past few years shows that 80% of companies have a negative cash flow. While that’s not a guarantee of future performance, it’s still pretty scary to have high expectations in such a company. I’m not saying that you can’t take risks here, I’m encouraging you to take an appropriate amount of risk depending on your risk tolerance and capacity. Chances are, your net worth will probably oscillate quite a bit—perhaps growing the size of your salary and back down all within a single day. Don’t pay too much attention to the stock price. You won’t be able to do anything anyways. You’ll most likely be unable to sell immediately upon IPO, so there’s no use doing math in your head to figure how much it’s worth. Chances are it could have dropped by the time you are able to sell. Stick to the plan. Not every IPO will go up. If it does go down, it might never come up, or in the case of facebook, it took a year to recover to its IPO price. Everybody has expectations for the IPO and a 50% drop isn’t one of them.
Nobody’s rich yet—except for the bankers and underwriters that helped your company to this point. Here’s why…
Stage 3: Post-IPO
Inside the Company
The underwriters that helped take the company public will take a healthy fee and then typically purchase the first block of shares before the IPO. As a way to protect their new investment, they create some rules for all pre-IPO shareholders. The most well known of them all is the lockup. The lockup period is a time frame where you’re restricted from engaging in transactions with the stock—typically 180 days long. If you’re lucky, it could be shorter. Sometimes they restrict your ability to pledge, transfer, offer, or exercise your stock options, but most of the time, they disallow you from selling your company stock. It’s important to note, that if you can exercise during the lock-up, taxes aren’t delayed until post lockup. They’re often due sooner. To be clear, the lockup period isn’t the SEC or IRS imposing this, but the underwriters or bankers who are protecting their investment. That means, if your company goes public through a Direct listing (like Slack and Spotify did), there isn’t a lockup period. Direct listings don’t require an underwriter because the company doesn’t create new shares—it uses the already existing ones.
In addition to the traditional IPO process and direct listing, there’s also one more way a company can go public—Special Purpose Acquisition Company (or SPAC). In the traditional IPO route, is where a private company raises capital through selling newly-issued shares to investment banks (underwriters). These bankers then sell to institutional investors. This allows the private company to be more picky with who their initial investors are and get marketing and other assistance from the underwriters. This can be a more expensive and time-intensive route. To circumvent these fees and other business-specific reasons, a company may choose to take the Direct Listings IPO route. The Direct Listing route allows the shareholders to sell directly to the public without raising new funds in the process. Companies typically need to have a strong brand recognition if they choose this route (for example, Spotify). Lastly, a company may choose to IPO via SPAC if they’re looking to raise a specific amount with strategic partners in a shorter time frame. SPACs are also known as Blank Check companies because they are a shell company that merges or acquires a private company. The combining of these companies through a de-SPAC merger results in the company going public. They receive proceeds from both the IPO and from private financing.
Regardless of how a company IPO’d, they’ll eventually start to grant new shares under the revamped equity plan and they will also build out the insider trading policies. You can learn more about the new equity plans by looking up form S-8.
Personal Impact
What to do while after your company IPOs
First and foremost, congratulations if you’ve made it to this point. I recently had a client explain their liquidity experience as validation for picking the right company. There’s risk in joining a startup and very few ever make it to this point.
Once the lockup is complete, it now makes sense to look at the stock price. If you’d like to exercise some of your stock options, you’ll want to ensure that your options are above water (or in-the-money). That just means that the fair market value (FMV) is higher than the actual exercise price. If you do choose to exercise your options, I’d invite you to do a net exercise or a sell-to-cover so that you actually have enough proceeds to cover taxes. Assume your stock isn’t going up and pay your taxes now. Don’t wait until tax time to sell. I’ve had clients go against this advice because they thought they’d “wait for the stock to go up” before selling and paying taxes. Problem is, the stock didn’t go up. They had a large fixed expense (in the tax bill) and a decreasing stock price from which to pay it. Don’t try to outsmart the system, be conservative and play it safe. You’ll have a co-worker or two, who were dumb and accidentally guessed right. Tell them to do it again, and chances are, they won’t be able to.
It’s not a direct correlation between effort, skill and wealth. Dumb, lazy people will get rich. Smart hard working people may not get as large as a payout. It’s not about other people. Don’t compare. If you do this, you’ll either feel bad about yourself, or you’ll get confident and take on dumb risks—neither of which is a good option.
As you make decisions around exercising and selling, you’ll want to ensure that you’re aware of trading windows and blackout periods where you’re not allowed to trade. Also, if you’re an executive who needed to create a 10b5-1 trading plan, it’s now your job to keep the rules that the plan established. Be aware of insider trading policies as fines can be a multiple of the actual value of your stock. The SEC doesn’t joke around with this stuff. It’s not a slap on the wrist.
When you do sell, you can be strategic about what shares you sell to reduce taxes. Your shares will likely have different cost basis and holding periods. If you’re in a high income tax bracket year it may make sense to sell high cost basis stock with long-term holding periods. To the contrary, if you’re in a low tax bracket this year, you could consider selling low basis stock with short-term holding periods if it aligns with your unique goals.
Once you sell, you’ll want to do a couple of things. First, take care of taxes. Ensure your withholdings are accurate as you start selling shares. Second, you’ll want to diversify. Your income is already tied to the company. We don’t want your whole net worth tied up too. Will the difference in having 100% of your shares and 75% of your shares actually be the difference in you “making-it.” Probably not. That’s why I encourage my clients to sell 25% of your shares as soon as the lockup period ends. There are different approaches you could take here. You could sell a fixed dollar amount each year or sell at a specific price point, etc. The IPO may create wealth, but diversification can keep it.
If you still have RSUs vesting, it usually makes sense to just sell them as soon as they vest. It’s common to view the vesting RSUs as a cash bonus. If you had given you $50,000 in cash (or whatever your RSUs are worth), would you invest back into your company?
Whether you made it big or not in the IPO, you need to stick to your plan discussed earlier. If you didn’t make it big, it shouldn’t be cause for concern because hopefully you’ve already stayed on top of your retirement contributions, emergency fund, and so on. If you did “make it” big on the IPO, continue to stick to the plan. Just because you can afford something now, doesn’t mean that you should actually buy it. Be smart with your money and catch up on any key financials you’re behind on such as funding a child’s education, reducing unnecessary high-interest debt, etc.
Whether you made it big in the IPO or not, just remember that the wedding (IPO) is just the start of so much good to come.
