10 Things to Consider Before Your Company Files an IPO

The following is a guest post by Lock Bingham, a Vice President of Investments at Stifel, Nicolaus & Company, based in San Francisco. More about Lock, including his contact details, can be found here: http://www.lockbingham.com/.

If you work at a company as it prepares and ultimately succeeds in an IPO, congratulations! However, there are a number of items that you should consider to make this event as successful as possible.

The items outlined below serve as a starting point, not necessarily a comprehensive review. Your financial advisor can help you navigate the complexities of your financial landscape and develop a customized strategy to help you pursue your goals.

Please Note: 1) Companies make changes to employee compensation packages in the pre-IPO period between filing with the SEC and the day their shares start trading on the stock market. I have seen employee compensation packages change during this window, and it can be startling for employees. Recently, I saw an entire team’s bonus package get reduced. This is another reason why it is critical to speak with a financial advisor. 2) The items below all relate to IPO considerations in the U.S. and may differ internationally.

1. Stock compensation

The first item to evaluate is your stock compensation. In what form were shares granted to you, and what is the tax treatment of those shares? Restricted stock units (RSUs), incentive stock options (ISOs), and non-qualified stock options (NQSOs) are all taxed differently.

Regarding RSUs, you should be aware of the date it was acquired, the date it vests, and the price at which it vested. Regarding ISOs and NQSOs (for each grant you have, if you have received more than one grant), you should be aware of the exact grant date, vesting start date, vesting schedule, class of shares, exercise price, and expiration date.

It can be surprising to investors when they learn that their options expire, most commonly 10 years from the grant date. If you exercised options in advance of the IPO, you may receive a lower tax rate, also called “long-term capital gains,” as long as you hold the shares for more than one year following the exercise. This may or may not reduce your taxes, so be sure to speak with a tax advisor.

2. What is the lock-out (or “lockup”) period for insiders?

Insiders, including management and employees of the company, will usually be prohibited from selling stock for a certain period following the IPO. This may significantly affect your personal planning. For example, you may consider exercising options soon so that you have long-term capital gains tax treatment when the lock up expires. In addition, once your company goes public, you will have blackout periods where you cannot transact in the company shares.

3. How will it impact your taxes?

This is a big consideration. Each individual’s tax situation is different, so it is important to speak with a tax advisor before the event takes place, preferably as soon as you know an IPO is imminent.

Planning ahead will help you to make decisions in advance that could significantly reduce your taxes. A large amount of income in one year could change your effective tax rate and could impact other income and taxes. I recently met with a client who, before meeting with me, exercised his options, sold the shares on the same day, and didn’t withhold enough money for taxes. He will be hit with an additional $100,000 in taxes next year that he wasn’t planning on.

4. What are your long-term goals?

This public offering may generate enough money to change your and your family’s lives. That’s why it’s important to discuss your long-term goals with your loved ones. Financial planning is about defining your values and goals, and then working backward to figure out the steps to get you to where you want to be.

If you have clearly defined goals, you can take steps now to help you pursue those goals. Ask yourself: What is most financially important to you? Where do you want to be in five years, 10 years, and beyond? Do you want to provide for your next generation or the generation after?

5. Pre- or post-IPO gifting

The federal estate and gift tax exemption allows each individual to transfer wealth before the imposition of transfer tax. In 2019, the exemption is $11.4 million per person. If the majority of your net worth is in your company, you or your heirs might have to sell stock to cover taxes. Keep in mind that assets can appreciate significantly in the future, so you may not be near the exemption now, but you might be over it in time. To plan for this, you can gift low basis stock to different types of entities. This can exclude future growth from your estate.

There are many different kinds of trusts and partnerships (including family limited partnerships) with varying goals. One strategy is gifting low basis stock to a trust for the benefit of your children, which would exclude the growth from your estate. You can gift it at $1 per share today, and if the stock’s public offering is at $30 in the future, the entire growth would be excluded from your estate.

Alternatively, if the stock has already appreciated, you can gift appreciated low-basis stock to a Donor Advised Fund (DAF), which is considered a donation. This fund offers a tax deduction when you gift to it, and then you can use the money in the fund whenever you want to give to charities. The benefit is you get the tax deduction at the current market value of the shares, not the price at which you bought them. This can be helpful to do in a year when you have a lot of gains. Talk to your financial advisor about additional strategies that may better apply to your personal situation.

6. How much diversification do you really need?

Real money is made in concentrated positions; real risk is taken there too. Everyone needs diversification, but how much is enough? Many of my clients are surprised when I tell them that they should keep an allocation of their company’s shares; a reasonable amount that is unique to their personal situation. For example, imagine a company that started in a garage with two owners dedicating a majority of their net worth to the company. If it succeeds, they and their families’ lives are changed forever. If it doesn’t, they’re broke. When an investor has liquidity event, it is important to diversify, but not over diversify away too much additional potential growth.

You should also take into consideration the company’s unique characteristics, your personal situation, and the market cycle. I had a client with a significant allocation to his company stock. It was 90% of his portfolio when we first met. Over a period of four years, we opportunistically diversified but also left him with an allocation to his company stock. Assuming the company does well, that allocation would provide for faster long-term growth than a typical diversified portfolio.

7. Are you interested in helping nonprofits?

If you are interested in helping charities, you can set up a charitable remainder trust or a foundation. This can be implemented after you receive the IPO proceeds, but must be in the same year if you want to use the tax deduction. The charitable remainder trust allows for you to get a tax deduction in one year and receive an income over subsequent years, with the remainder going to charity.

8. What are your options for borrowing against the shares?

Many firms can provide lending to individuals to buy stock. There may be a way for you to exercise the stock before the IPO by borrowing money from the brokerage firm managing the IPO. In addition, there are companies that will provide you with liquidity before the IPO for your shares. Terms vary widely, so it is worth doing your homework. For example, one firm I know will give you cash for a portion of the upside in your shares. It is critical to ensure any actions you take do not violate rules set by the company or FINRA regulations.

9. Understand the company

It’s important to maintain an objective view of the company. Once it is publicly traded, it will either make money or lose money. Yet this is a company you have invested blood, sweat, and tears in potentially for many years, and likely are emotionally and financially invested.

That’s why it’s important to remain dispassionate and unbiased. Where is it today and where will it go? How much certainty is there and how much uncertainty? I can think of more than one example of a company stock that did very well for a short while – and then didn’t. In those cases, selling some shares when the lockup expired was the right thing to do. My heart goes out to insiders that hold too much stock through the lock up, and it doesn’t turn out right.

10. Review your estate plan

If you have any dependents, this is a priority. At the very minimum, you should have a living trust that outlines where your assets go upon your death and who will make decisions for you if you can’t. You’ll need to have financial powers of attorney so that a trusted person can make decisions over your financial assets if you can’t. You should make sure that you have the correct beneficiaries for all of your assets – including your stock compensation. You may be able to transfer RSUs into a trust after it has vested. If you haven’t reviewed your estate plan in a while, it is a good idea to review it and meet with an estate attorney.

Every investor is different, and there is no universal answer that fits all situations. However, you can take the first step and find out how Stifel can assist you with your decision process.

Disclaimer: Stifel does not provide tax advice. You should consult with your professional tax advisor regarding your particular situation.

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