Navigating the IPO Journey

ANTICIPATING YOUR IPO

In the dynamic landscape of the Bay Area, risk, reward, triumph, and tragedy abound. Nothing represents all of these elements more than being part of a technology company, aiming to become a public entity through an Initial Public Offering (IPO). Despite the inherent risks of taking a company public, for many founders and employees, it’s viewed as the ultimate attainment in tech. It promises sudden affluence, low-cost funding, prestige, validation, and the ability to attract top-notch talent.

As Bay Area-focused wealth advisors, we have a significant amount of firsthand knowledge having advised many clients through their IPO journey for the past 20+ years. This life-changing event is accompanied by a host of complex considerations, such as how many pre-IPO stock options to sell, when to sell them, managing tax implications, which professionals to hire, evaluating whether to buy or sell a home, deciding to remain with the company post-IPO, etc. Embarking on the journey of going public triggers a confluence of emotions including joy, worry, and stress. Preparation and planning for your company’s IPO, particularly as it pertains to your restricted stock units and stock options will be crucial. However, the first step in your post-IPO path will be to wait.

THE LOCK-UP PERIOD

During a pre-designated duration known as the “lock-up period,” employees are strictly barred from offloading their shares. The duration is typically between 90 and 190 days and often drives a dip in share prices right after the period ends. The drastic fluctuations in share values over the months can leave the workforce uneasy, and as the restriction lifts, they may decide to trade away all or a portion of their holdings. The root of this volatility lies in the absence of prior transactional data to calculate the “fair value.” For many companies that go public, particularly in the tech and biotech sectors, the road ahead may be even more challenging as these businesses aren’t yet profitable. This reality further muddles the valuation process, leading to share price ambiguities and variability. As an insider associated with the company, such as a director, significant shareholder, officer, or board member looking to sell shares, it’s mandatory to draft a written plan adhering to Rule 10b5-1. Introduced by the Securities and Exchange Commission (SEC) in 2000, this rule aims to provide insiders with a transparent and lawful framework for company stock trading, ensuring strict compliance with regulations.

CHOOSING WHETHER TO EXERCISE OPTIONS

If you possess options that haven’t vested yet, most likely nothing will change. Your vesting plan, the number of shares, and the exercise price will continue under the newly public company. For vested options, the main advantage is the established active market into which you can exercise and sell, post the lock-up period. After your options vest and as long as the market price of the stock is greater than the exercise price (also known as “in the money”), there comes a decision point: whether to exercise and hold, or to exercise and sell. The tax consequences of exercising depend on the type of your options, the duration of shareholding post exercise, and the date of grant. Remember that “exercising” means purchasing the shares at a pre-determined price. So, if you decide to hold and not sell immediately, be prepared to pay for the shares from external resources.

Restricted stock units (RSUs) are regarded as the simplest and most common type of equity compensation. An employee receives a certain number of shares that vest in the future. Often, shares vest over several years. When the shares vest, their value is treated as ordinary income and taxes are due. This form of compensation works well with public companies, where shares are automatically sold in the open market to cover federal and state taxes. However, the challenge with RSUs in a private company is that although shares are taxed as ordinary income to the employee, there is no open market to sell the shares. The cost can be prohibitive even if a venture capital firm or company executives agree to buy the shares. If an employee possesses vested or unvested RSUs in a private company, typically nothing changes post-IPO except there is now a public exchange to sell your shares. It’s crucial to review your company’s stock plan agreement that details the provisions in the case of a merger, acquisition, or IPO. You might gain from quick stock-based compensation vesting under specific qualifying circumstances.

FINAL WORDS

As illustrated above, you will face several choices as you near a public offering. Understanding the IPO process and having a well-thought-out plan is important to fully take advantage of your company’s IPO. Every circumstance is unique and dependent on your stock plan agreement’s details, which type(s) of equity compensation apply, and your position in the company. Depending on your specific circumstances, an IPO will likely necessitate a thorough review of your financial life. Your personal net worth is only one aspect to consider in the shift towards public trading. The number of financial decisions to be made also increases significantly, including many complex and impactful considerations.

• How can you minimize taxes and avoid penalties and interest?
• Is a donor-advised fund or a foundation the best structure for your charitable giving?
• How do you reduce or lower potential estate tax?
• Can you consider yourself in the “work optional” stage of life?
• Do you have a concentrated stock position to address?

To create a plan to capitalize on this highly fortunate, but probably once-in-a-lifetime event, consider consulting with a Summitry Financial Advisor.

This article is for informational purposes only. Summitry, LLC does not provide tax advice. Information contained herein is not a suggestion to purchase or sell any securities. In addition, the information presented here are opinions and advice of Summity, LLC and is subject to change and dependent on each individual’s circumstances.