Determine what precisely you own
Now that the rubber has hit the public offering road, the details of what is in your portfolio will no doubt begin to take on considerably more weight and urgency. If, for example, you have restricted stock or restricted stock units (RSUs) — i.e., shares or units that typically vest over time based on your length of employment or certain performance benchmarks — the IPO may very well be the trigger to finding out what you actually own. Which means you are not only close to knowing the actual size and shape of your potential windfall, but also to having to grapple with the accompanying personal finance, tax and regulatory implications.
As far as employee stock options, which are a set number of shares an employee is allowed to purchase at a specific price over a set period of time according to a vesting schedule, are concerned, a whole host of issues are at play. Among these are when you should exercise (i.e., pre- or post-IPO), whether your grant is an incentive stock option (ISO) or non-qualified stock option (NQSO), do you have the liquidity to purchase the shares and cover the income tax, and your investing time horizon and risk tolerance level.
Use delays to inform decision-making
When a company goes public, there is a lock-up period — typically around 180 days — that prevents an employee from selling their stock. And for good reason: Without one, overly exuberant insiders could sell a plethora of shares immediately after IPO, distorting — and, perhaps, depressing — the stock price just as general investors are getting their first crack at it.
Of course, this can be a nerve-racking time for employees such as yourself who are essentially asked to sit by and watch any price fluctuations without recourse. On the other hand, one can also look at this as an opportunity to digest the IPO, the market and public reaction to it, and consult with seasoned advisors about best next steps to take once the dust settles.
What, for example, are the pros and cons of selling immediately after the lock-up period versus selling on a predetermined schedule — say, a certain percentage each quarter to hedge against potential volatility? How can you best integrate your post-IPO stock into a properly diversified portfolio that will serve your short- and long-term goals? What context might you be missing regarding both the potential upside and downside of the stock by virtue of your emotional and financial proximity to it?
The answers to all of these questions will likely be easier to find with an outside, experienced perspective on hand.
Develop an investment strategy
Your goal in the immediate aftermath of an IPO is, somewhat paradoxically, simple but not easy. Essentially, you’ll want to integrate the pros and cons of the aforementioned acronyms — RSUs, ISOs and NQSOs — into your own slate of resources, needs, and short- and long-term goals. That may mean accepting the tax exposure of an immediate payout in order to pay down high-interest debt.
Or, conversely, holding stock for long enough — a year — to transform what would’ve been classified as a short-term hold and taxable as ordinary income to the typically lower long-term capital gain rate. A financial advisor can help you more fully understand your menu of options and tailor your strategy accordingly.
Don’t let lax tax planning reduce your bounty
If you think you’re happy about your windfall, imagine how Uncle Sam feels: After all, depending on the amount of money you net from an RSU vesting or stock option, you could land in a higher personal tax bracket, facing an increased alternative minimum tax or calculating new capital gains tax exposure. And then there’s state and possibly local tax liabilities as well.
The key here is to understand the nuances. In the case of an NQSO, for example, your tax exposure is determined as soon as you exercise the option — i.e., your standard income tax rate on the difference between the exercise price and current fair-market rate — with capital gains coming in after you sell if you held on to any shares after exercise and there was further appreciation.
Meanwhile, an ISO, as its name suggests, has greater complexity and is potentially more favorable from an income tax perspective, capital gain treatment. Although, even under this scenario — as noted above — when you sell can have a substantial impact on the size of the check you’ll have to send to the government and the alternative minimum tax will have to be evaluated.
There are also a couple of tax elections under IRC section 83 you may be able to make that convert potential future ordinary income to capital gain or defer the payment of taxes. Additional tax incentives may also help manage and mitigate your capital gain exposure by taking advantage of Qualified Small Business Stock treatment if certain criteria are met. A CPA and/or tax advisor well versed in these areas can offer often priceless insight and advice.
Think before you spend
A lot of temptation to shift money around is to be expected. Depending on the size of it, you may simply get a little too casual with your spending or, further up the mountain, begin to have visions of sleek boats, fancy cars and budget-stretching houses dancing in your head. The best way to counter this? Know thy financial self. Prioritize. Visualize. Consult experts. Plan. Budget. And you’ll be much less likely to get off track.
Be wary of 100% cash purchases
Yes, you should be living within your means. No, you shouldn’t be carrying credit card balances chock-full of impulse purchases. That said, when it comes to medium to large outlays, just because you can pay in all cash doesn’t necessarily mean you should.
Pro tip: Work with your financial advisor to come up with the best plan of action that takes into account your unique financial situation.
Create an estate plan
One of the greatest gifts you can give your loved ones is a peace of mind during an extraordinarily difficult time. If you don’t have a will, a financial windfall can serve as a great prompt to put your wishes down in writing, create a legacy on your own terms and ensure the distribution of your assets — both financial and personal — is as smooth and painless as possible should the unexpected happen.
Evaluate new investment opportunities carefully
It’s worth noting, too, that those who peddle risky investment schemes have an extraordinarily good nose for “new” money. While there is a time for embracing bold and exciting investment opportunities, vet your potential partners well. Also, if you choose to launch a new business, avoid financing it entirely with your new windfall. As always, a good rule of thumb is to believe in yourself but be mindful of placing all your eggs in one basket.
Enjoy the fruit
Remember, this is part of the compensation for all your hard work. Honor it as such, and it is more likely to be enduring rather than fleeting.