If you hold shares or options in a company expected to undergo an initial public offering (IPO), you’ve likely imagined what happens after the IPO, including the many ways newfound wealth could change your life. What you’re probably not thinking about are concentrated asset mitigation strategies, restricted stock options, or 10b5-1 plans. However, these types of financial planning considerations should be top of mind if your goal is to help preserve your newfound wealth over time.
In this article, we’ll discuss what to do after an IPO, including financial planning after an IPO, IPO tax considerations, and how to create a post-IPO plan.
What Happens to Your Equity When Your Company Goes Public
When an IPO occurs, your existing company shares will convert to publicly-traded stock. Any vested options will retain their strike price, which means you can exercise them once trading opens. Any unvested options will continue vesting on the same schedule.
If you hold restricted stock units (RSUs), which are awarded (not purchased), there are usually two vesting requirements, also known as double-trigger RSU vesting. Since the second trigger can be an IPO, going public can create a significant tax burden, as the RSUs may fully vest at that time and be taxed as regular income.
Perhaps the least understood part of an IPO, but also one of the most important, is that after the company goes public, your newfound wealth will still be largely inaccessible. This is due to restrictions on the sale of stock after the IPO. These rules include a “lockup period” during which a contractual restriction prevents insiders who acquired company shares pre-IPO from selling the stock for a given period of time after the IPO. Although this waiting period can and does vary, it typically ranges from 90 to 180 days following the IPO. Generally, the company’s founders, owners, managers, and employees are subject to these lockup periods. However, these same restrictions can apply to venture capitalists as well as other early private investors.
The primary rationale for this blackout period is to stop investors from flooding the market with a large volume of stock, which would depress the stock’s value. High-volume selling by insiders could dramatically impact a company’s share price immediately after going public.
Even when not in a post-IPO quiet period, the sale of publicly traded stock may require advance planning and approval through the creation of a 10b5-1 plan. This plan outlines how to sell shares after the IPO—specifically the amount of stock to be sold and when—and must be approved by the company in advance.
You also can’t actually sell the stock yourself. You have to have a third party do it for you, typically a broker-dealer or a bank affiliated with a broker-dealer, and it must be approved in advance.
Many public companies also have a holding requirement for insiders, such as senior executives receiving equity compensation, meaning they are required to hold a minimum amount of stock as part of their compensation agreement.
Managing Liquidity While Your Shares Are Restricted
Considering the restrictions outlined above, it’s important to carefully think through how much money you will need on-hand to live the lifestyle you and your family desire to inform your post-IPO strategy. This is a core consideration, because liquidity can be hard to come by after an IPO.
But there are options to get at the liquidity you may desire. Among those options are securities-based lending, including both purpose and non-purpose loans. A purpose loan is when you borrow against your stock, essentially using it as collateral, and purchase new securities with those funds to diversify your assets. With non-purpose loans, you are also borrowing against your stock, and you can use those funds to purchase anything BUT additional securities, such as real estate, vehicles, etc. Both of these types of loans are usually offered by broker-dealers or banks affiliated with a broker-dealer.
If you do liquidate any stock options, it’s important to anticipate the tax consequences of those sales and plan for it as part of your post-IPO strategy. You want to avoid a situation where you have a tax bill you cannot pay because you don’t have the liquidity. That may force you to sell even more stock, which sets up a cycle you don’t want to be in. This is one of the many reasons why financial planning after an IPO is so important.
Strategic Tax Planning for IPO Windfalls
Post-IPO tax considerations will vary depending on the type of shares or options you have and whether you choose to purchase, hold, or sell your shares.
- Restricted Stock Units (RSUs): These shares are valued as common stock and will be taxed as regular income on vesting. If they are double-trigger RSUs, they may vest at the time of the IPO. Because the IRS does not classify RSUs as tangible property, they are not generally eligible for 83(b) election. Therefore, only the fair market value of the shares on the vesting date matters, and this amount is reported as ordinary income.
- Incentive Stock Options (ISOs): Once exercised, sales of these shares are subject to holding periods, which determine whether the sale is “qualified” or “disqualified” for tax purposes. To be considered “qualified” (and receive the subsequent tax benefits), the sale must happen more than 1 year after the date the options were exercised, and more than 2 years after the date the options were granted.
- Non-Qualified Stock Options (NSOs): NSOs do not qualify for special tax treatment like ISOs. When NSOs are exercised, the “bargain element,” which is the market value minus the exercise price, is treated as regular income, and therefore subject to federal, state, and employment taxes.
- Restricted Stock Awards (RSAs)/Founder Shares: After an IPO, these shares are taxed based on whether you filed a Section 83(b) election when you first received them. 83(b) elections allow you to pay taxes on the total fair market value of restricted stock at the time they are granted instead of waiting to pay taxes when they vest. This can significantly reduce the amount of taxes owed, because the share price at the time of the grant is often much lower than the price at the time of vesting.
In addition to the type of shares and options you hold, there are a number of other key considerations, including:
- Alternative Minimum Tax (AMT) exposure: Exercising ISOs before an IPO and selling shares post-IPO can trigger AMT exposure. Mostly impacting high-income taxpayers, this occurs when your Alternative Minimum Taxable Income (AMTI) surpasses the exemption amounts set by the IRS. This is due to the “phantom income” created by the difference between the set price and the fair market value when the options were exercised.
- RSU withholding shortfall: This tax gap occurs when your employer withholds taxes from your vesting RSUs at the flat federal rate of 22%, but your income pushes you into a higher tax bracket, such as 32%, 35%, or 37%. The result can be a significant tax bill when it’s time to file your returns.
- Qualified Small Business Stock (QSBS) eligibility: If your stock qualifies for the QSBS tax exemption, when the stock is sold, you may be able to exclude a portion of capital gains depending on when the stock was issued and how long it was held.
- State of domicile: Your state of domicile determines how your income is taxed. Some states, such as Florida, Texas, and Nevada, have low or no income tax, while others, like California and New York, have high income tax rates. Changing your state of domicile could potentially lead to a significant amount of tax savings, but note that residency changes tend to be heavily scrutinized when a significant liquidity event occurs.
If you’re looking for ways to reduce your overall tax liability post-IPO, charitable giving can be a valuable tool. For instance, contributing highly-appreciated, low-basis stock to a Donor Advised Fund (DAF) may allow the donor to avoid paying capital gains tax on the appreciation of the donated stock while receiving a deduction for the fair market value (subject to AGI limits).
A charitable remainder trust is another option for combining tax optimization with charitable giving. CRTs provide income for the donor or their heirs for life, with the remainder going to charity. They also offer both income tax deductions and reductions in estate taxes, making them a useful tax strategy.
Managing Concentration Risk
One of the primary risks of an IPO is a highly concentrated position in one company’s stock. In other words, after a company goes public, the vast majority of your net worth could be tied up in that single stock.
There is an inherent risk associated with a highly concentrated position. As that stock goes up, yes, your net worth goes up. But as it goes down, your net worth also goes down. When you are primarily invested in just one company, those ups and downs can be quite volatile and unnerving. You ride the rollercoaster of the value of that stock.
How do you avoid that rollercoaster? It starts with a comprehensive plan to build, or potentially rebuild, a portfolio beyond that one security. Often called “diversifying out of stock,” the goal is to start structuring or reallocating your wealth independent of the stock associated with the IPO. That can be done via purpose loans, but also via carefully staged and planned sales of stock that over time create the desired level of diversification. Other options include hedging and deferral tools, such as collars, prepaid variable forwards, and exchange funds.
Estate & Wealth Transfer Planning After an IPO
Everyone going through an IPO should consider establishing a will, power of attorney, healthcare directive, and other basic estate planning documents. For more complex situations, options may include strategies such as the establishment of revocable living trusts, family limited partnerships, or other more advanced planning strategies such as grantor retained annuity trusts (GRAT) or charitable remainder trusts.
An IPO can be an exhilarating experience and an immensely satisfying culmination of many years of hard work and sacrifice. To make your newfound wealth last for you and your family as well as future generations, it’s best to work with professionals who can help you prepare for and navigate the intricacies and complexities of your life post-IPO.
Assembling Your Advisory Team
The best time to start planning for your post-IPO life is well before the IPO happens. There are many crucial considerations to weigh and time-sensitive decisions to make. Working with an expert financial advisory team can help you be as prepared as possible, both emotionally and financially, for the life-changing experience of an IPO.
Remember these four important considerations:
- Prepare to be patient
- Evaluate your liquidity needs
- Mitigate your risk
- Be proactive with planning
Frequently Asked Questions (FAQs)
What is the meaning of post-IPO?
When a company is post-IPO, it means it has undergone an initial public offering (IPO), and its shares are now publicly traded.
What happens to a stock after an IPO?
After an IPO, private shares are converted to publicly traded stock.
Can you sell IPO shares immediately?
After an IPO, there is usually a “lockup period” during which the company’s founders, owners, managers, employees, and sometimes early investors are prohibited from selling stock for a specific period of time. This period usually ranges from 90 to 180 days following the IPO.
What is post-IPO equity?
Post-IPO equity is your ownership in a company after it undergoes an initial public offering (IPO).
What are the best strategies for managing IPO windfalls?
The best strategies for managing an IPO windfall will vary depending on the award types you hold and your unique financial situation and goals. It’s recommended to consult with a financial advisor to explore which strategies are right for you.
Do I need a financial planner after an IPO?
If you want help maximizing your wealth and reducing your tax liabilities, then working with a financial advisor is a good option. Generally, the sooner you start working with them, the better.
What happens to my unvested RSUs and options when my company IPOs?
Any vested options will retain their strike price, which means you can exercise them once trading opens. Any unvested options will continue vesting on the same schedule. If you hold double-trigger RSUs, the IPO may trigger the RSUs to fully vest at that time and be taxed as regular income.
How long does an IPO lockup last?
Although the IPO lockup period varies by company, it typically ranges from 90 to 180 days following the IPO.
What is a 10b5-1 plan and do I need one?
A 10b5-1 plan is a written, prearranged plan that specifically sets the amount of stock to be sold and when that must be approved by the company. It provides an “affirmative defense” to the seller against potential insider trading accusations. Corporate “insiders” with regular access to sensitive data such as executives, board members, and major shareholders who plan to buy or sell company stock should consider a 10b5-1 plan.
Should I sell my stock as soon as the lockup expires?
There is no one “right” decision when it comes to exercising, holding, or selling your stock post-IPO. It depends on a number of factors unique to you, including your current financial situation, immediate needs for liquidity, long-term goals, number and types of shares, market volatility, and much more. Working with a trusted financial advisor can help you decide whether selling your stock when the lockup period expires is the right option for you.
How much of my net worth should be in company stock?
If you have a single stock that represents 10% to 20% or more of your portfolio value, you likely have what is called a concentrated stock position. Because of the inherent risk associated with a highly concentrated position, if you want to safeguard your wealth for the future, you may want to consider working with a financial advisor to diversify your holdings and reduce risk.
To learn more about how Cresset can help you create and execute a post-IPO plan, contact us today. Where you are in the IPO timeline can ultimately determine your planning window and what options are available to you, so don’t delay! The earlier that planning for an IPO begins, the better.