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How Should Startup Employees Prepare for Life After Liquidity?

As an IPO — or any exit, for that matter — approaches, startup employees must begin to grapple with how the transformation to a publicly traded entity will fundamentally alter not just day-to-day operations but also their lives, particularly if they’re anticipating a post-exit windfall.

So how best to prepare equity-holding employees to navigate the changes and choices that arise before, during and after the big day?

Pre-IPO: Planning for the implications

An impending exit often has employees scrambling to understand what the company’s liquidity may mean for their finances. But reaching the “impending exit” phase takes longer than it used to for private companies — currently averaging roughly 8–10 years.

“Years ago there [tended to be] a shorter duration between founders raising capital and going public,” commented First Republic Bank Regional Managing Director Bill Dessoffy. “Now that it’s longer, it puts pressure on founders and also on individual employees as the company keeps going. How do they meet life needs and have private equity in the work they do?”

Using private, pre-exit equity to finance life before liquidity is risky. Given the unreliability of startup shares as an asset, Dessoffy said most banks don’t lend on options pre-exit.

That said, a bank may factor private company holdings into a customer’s overall balance sheet and asset mix. And certain funds do allow equity options — based on assessments of the future stock’s potential performance — to be used as collateral but may stipulate that distributions from the IPO event be earmarked to pay back the loan. This can lead to precarious situations for customers, since share prices are unpredictable and valuations can fluctuate wildly in the weeks preceding an exit.

That’s partly why employees should take the time to understand how their option plans work — and well before valuations are even on the table. Tax implications for selling shares vary drastically for incentive versus nonqualified stock options, for example. Employees may also face more or longer restrictions on their ability to sell shares post-event than they realize in the IPO run-up.

Shutterstock Founder and CEO Jon Oringer — who took his company public in 2012 — explained that respecting the potential for unexpected lockups “gets more important the more senior you are in the company.” Why? Because access to sensitive information may compel the leadership to close a selling window “when you least expect it.” Entering into a planned selling arrangement in advance of the exit — or during non-lockup periods — is thus sometimes advisable for individuals at more senior levels.

The event: Managing the exit wisely

As valuation talks get louder, it’s important to ensure that employees don’t get so carried away calculating windfall potential that they begin “losing attention to the business at hand,” Lux Capital Cofounder and Managing Partner Josh Wolfe warned.

“I had a partner employee at a [portfolio] company who was horrible at math, but he could instantly tell you the value of any potential share price multiplied by the over 3 million shares he had,” Josh recalled of one exit. “That’s what it’s like sometimes as people start thinking about net worth.”

In short, long-term thinking can fall by the wayside when people are anticipating wealth. And the excitement of a liquidity event — following months of buildup and internal culture change — tends to exacerbate the problem.

The ability to hold on to post-IPO equity and allow one’s stake in the company compound tax free, for example, is something many employees neglect to consider in their eagerness to buy homes or pay off debts.

It’s important to view the equity as a potential asset rather than simply a placeholder for cash to be sold as soon as the opportunity arrives. In fact, during the run-up to an exit, Wolfe advised employees not to raise their expenses substantially, take on inordinate amounts of debt or otherwise “create conditions where you’re forced to sell.”

Post-IPO: Welcoming a new reality

For those not in forced-to-sell conditions, an IPO itself can be somewhat anticlimactic: “It goes public, and you have a big celebration,” Greycroft Partner Ellie Wheeler said, “but then you go back to work.”

“The world will have changed in some ways, because you’ll have friends and family who are going to have a better sense of what it is you do — or at least what the company does — because there’s a lot more that’s publicly available now,” Wheeler continued. “But that also means you’re going to be more popular with people from other sectors too — whether it’s different service providers or people you know who think you’ve suddenly come into a windfall.”

Remember, though service providers try to sell newly exited employees on exotic financial products, discipline and due diligence are key to investing a windfall wisely, and, ultimately, you’ll want to diversify your newly bolstered portfolio after an IPO.

Investing in low-volatility “liquidity instruments” such as structured S&P 500 funds, more than one panelist suggested, can be a smarter play in some circumstances than “sexier” alternative asset products. And, as an audience member noted, exiting employees may find it worthwhile to look into tax opportunities such as the 83(b) election.

It’s also never too early to consider forming trusts, investing in real estate or startups, or creating business vehicles to put one’s holdings to use. Further, if you believe in the company, holding on to shares as part of your overall asset mix can be a tax-efficient strategy or an income-generating one, if dividends are paying. Overexposure is unwise, however, as no one can predict where the markets — let alone individual stock prices — are headed.

In the end, the emergence of a stock price changes the way employees and management alike understand and relate to the company. Sticking around isn’t for everybody — those who stay may struggle to adapt into public company employees subject to quarterly revenue targets and shareholder expectations.

The beauty of life after liquidity, however, is that a startup’s transformation to a public company can be gratifying, rewarding and literally life-changing for the team members who helped get the enterprise to that point. With the right financial partners and strategy, employees can make the right choices for the personal and professional futures they want to achieve.

The strategies mentioned in this article may have tax and legal consequences; therefore, you should consult your own attorneys and/or tax advisors to understand the tax and legal consequences of any strategies mentioned in this document. This information is governed by our Terms and Conditions of Use.

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