Four Financial Planning Concerns Before and After an IPO

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Working for a company that goes through an initial public offering (IPO) can have life-altering financial shockwaves. It can also lead to tax and legal concerns that should be tackled proactively to safeguard and maximize your windfall.

Seeking guidance from professionals like financial advisors, tax professionals, and lawyers can be the best path forward; however, it can be helpful to personally understand several chief concerns you must navigate once your company executes its offering. Here are four of the top financial planning concerns you will face before and after an IPO.

Concern #1: When and How to Exercise Your Stock Options

It’s important to understand your stock options may be either vested or unvested. Vesting is the process of earning an asset (such as your stock options). Your stock options will be unvested if you’ve not met the requirements outlined in your option agreement. To have vested stock, you typically need to work for the company for a period of time before you officially become the owner of the stock options. 

If you find yourself with unvested shares, the IPO typically does not change the vesting schedule. However, each IPO is different, and some deals have provisions that allow for the immediate vesting of options as part of the transaction. If your options have already met the vesting requirements, you’ll need to determine when to exercise them.

First, you’ll want to understand what is the strike price versus the internal company valuation of your options. The strike price, often called the exercise price, is the agreed-upon price at which a specific security (like your stock options) can be purchased until the expiration date. The strike price essentially determines the value of a stock options contract. If the current exercise price is greater than the fair market value of the shares, electing to exercise your options may not make sense. 

Not only is the relationship between strike price and fair market value important, but so is the timing of your exercise. You could reap substantial tax savings by exercising your options early to meet the long-term holding requirements, which allow your options to be taxed at lower capital gains rates rather than ordinary income tax rates. If you exercise your options in advance of your company’s IPO, you could benefit from long-term capital gains rates at the first opportunity you’re able to sell your company stock.  

An important consequence of exercising your stock options is it could trigger a substantial tax bill with no immediate cash proceeds to pick up the tab. There is also no guarantee that the IPO will occur, or worse, your options could go underwater, putting you at risk for a loss. 

Concern #2: When to Sell Your Company Stock

Many employees with company stock are often surprised they are prohibited from selling their shares after the IPO has taken place. This is known as the lockup period and can prevent you from selling your shares for upwards of 180 days. This means you are merely an observer of the company stock price while outside investors are able to freely buy and sell the stock. 

After the lockup period has passed, you’ll need to determine whether you want to sell some or perhaps all of your stock. There are three critical factors that should be assessed when making this decision:

  • Diversification. We never think it’s a good idea to have a heavy concentration of your wealth invested in one company. This is especially true if your income comes from the same company. Should your employer face financial trouble, you could risk losing substantial investment value and be out of work.
  • Tax considerations. With the sale of company stock, you may find yourself in a much higher tax bracket, resulting in a significant future tax bill. Do note that the length of time you’ve held your stock will determine if you are taxed at short-term capital gains rates or more favorable long-term capital gains rates.
  • Timing. Initial public offerings are often marked by extreme stock price volatility. For instance, Beyond Meat was up 163% after its first day on the market. On the other hand, Facebook’s stock price dropped over 50% during its first four months of trading. 

Given the unknowns around future stock prices, it is paramount to put a long-term strategy in place to take advantage of gains while limiting the risk of price drops.

Concern #3: Potential Tax Issues

Several tax considerations have been discussed so far, but there are other tax implications to understand, too.

You can save on taxes by gifting stock to family members or by donating some of your options to charity prior to the occurrence of the IPO. You can find more long-term tax savings by transferring company stock to a Trust before an increase in market value. For those philanthropically inclined, a Donor Advised Fund can be established to make tax-advantaged transfers to charities over several years.

By working with a financial advisor who can coordinate with tax advisors and estate planning attorneys, a long-term plan can be created to address the immediate tax concerns of the IPO while limiting the amount of money owed to the IRS.

Concern #4: Protecting and Growing Your Wealth 

With an IPO and subsequent sale of your stock, you could be left with significant assets to manage. Protecting and growing your newfound wealth often comes down to choosing the right investments. Creating a diversified portfolio that exposes you to the appropriate level of risk is just the first step. There are numerous considerations that should also be reviewed, including:

  • Protecting your assets. This means safeguarding against losses from lawsuits or costs linked with getting older, such as home healthcare or nursing facilities.
  • Investment choice. Creating appropriate tax-advantaged investment accounts helps minimize the tax implications of investment gains.
  • Developing an estate plan. Proactive planning is a must for the continued management of your finances in case of incapacity or death, while also ensuring the efficient transfer of assets to the next generation.

Begin Preparations for Your IPO

Collaborating with an Abacus advisor can help you better navigate the financial, tax, and legal concerns throughout the IPO process. We recommend you start planning for your company’s IPO as soon as you believe the company’s chance of going public is likely. This will let you plan for the many financial challenges that will need to be resolved prior to the IPO. 

There are many additional steps that will need to be executed immediately after your IPO takes place. Schedule a call with an Abacus advisor today to better understand how we can help you expand what’s possible with your money for this exciting opportunity.

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