How to Optimize Your Employee Stock Options After an IPO

Jessie Foster, Advanced Planner, First Republic Private Wealth Management
September 21, 2021

  • If your company is going public you may soon face some important financial decisions regarding your employee stock options. 
  • From evaluating your stock risks to weighing tax decisions, there are four key questions to ask yourself in the process. 
  • Once you have the answers to these four questions, consider these key strategies for navigating your compensation package through your company's IPO.

If your company is going public, you are facing some important decisions — with big potential financial implications. If employee stock options are a part of your compensation package, you want to make sure you're making the most of them.

Stock options give you the right to purchase a specified number of shares of company stock at a fixed price within a defined time frame. Your shares won’t be granted automatically: It’s up to you whether to exercise your option to purchase shares and when. After your employer goes public, each company has discretion over how it handles its stock option exercise — for example, senior company executives may have fewer choices than junior employees — so it’s important to review your employer stock option plan documents.

If you opt to exercise your employee stock options, you’ll have some choices to make. Do you want to sell all your shares, sell just some, or hold onto all of them? The decision isn't straightforward — among other factors, it depends on your appetite for risk and how much cash you have on hand.

Ask yourself these four key questions as you determine the employee stock option strategy that makes the most sense for you.

  • How do you feel about the company’s future performance? If you’re bullish about your company’s prospects and believe the share price will rise over time, you might lean toward holding more of your shares in your portfolio. However, if you’re not confident that your new shares will perform well in the market, selling some or all of them could be the right decision for you.

  • How much concentrated stock risk are you willing to have? It’s a high-risk-high-reward scenario when shares of a single company have outsize influence over your portfolio performance. Speak with your advisor to determine how much risk you can tolerate, given factors such as your age, asset mix and financial goals.

  • How much cash do you have on hand — and how much do you want to spend? In addition to the cash you’ll need to exercise your options and purchase the stock shares, you may need extra funds to pay transaction fees and any immediate taxes due. Consider any other short-term liquidity needs you may have.
  • How could your taxes be affected? Waiting can be worth it: You may pay a lower capital gains tax rate if you hold on to your shares for at least a year after exercising. This is dependent on the type of options you have. Consult a tax advisor to make sure there are no surprises.

The framework below can help you navigate your employee stock options strategy as you consult with your advisors.

Potential strategies for exercising your employee stock options

Exercise and hold all shares

Exercise and sell some shares

Cashless same-day sale of all shares

Buy shares and hold on to them.

Buy shares and immediately sell enough to cover the share purchase and any income tax. Hold the rest.

Buy and then immediately sell all shares.

How do you feel about the share price?

I’m confident the stock share price will trend upward in the future; I’m very comfortable with price fluctuations.

I’m optimistic about the stock share price rising; I’m mostly comfortable with price fluctuations.

I’m skeptical that the stock share price will move any higher; I don’t want to be exposed to price fluctuations.

How much concentrated stock risk are you willing to have?

If I will be holding a high concentration of company stock in my portfolio, I’m comfortable with that.

I’d prefer to take on a little less concentration of company stock in my portfolio.

I’d prefer to hold no company stock in my portfolio after exercising my stock options.

Will you have enough cash to cover any costs, fees and taxes?

I’m comfortable spending enough to cover share purchases, transaction fees, income tax and/or AMT and have plenty of liquidity to meet other cash needs.

I’d prefer to use my transaction proceeds, rather than existing cash, to cover the purchase price and transaction fees.

I’d rather not spend a lot of existing cash on this transaction.

What are the potential tax implications?

For more, see “Additional tax considerations” below

I may owe income tax or alternative minimum tax (AMT) — depending on what type of option I have — and understand I likely have to hold my shares for a year or two before selling to qualify for the potentially lower capital gains tax treatment.

I’m willing to pay higher income tax on the shares I sell immediately, if necessary. I understand I likely have to hold my other shares for a year or two before selling to qualify for the potentially lower capital gains tax treatment.

I’m willing to pay higher income tax on the shares I sell immediately. I understand that exercise costs and income tax will be withheld from my sale proceeds.

Additional tax considerations for employee stock options

Keep in mind that your tax treatment will depend on the type of options you have. Your company may have given you an incentive stock option (ISO), nonqualified stock option (NQSO), restricted stock plan or some combination thereof. For example, to qualify for long-term capital gains treatment, ISO shares must be held for at least two years from the grant date and one year from the exercise date. A tax advisor can help you determine what rules apply to you.

Selling your shares affects your income tax, so keep these four tax rules in mind as you decide on a strategy:

  • Any shares sold to cover costs are typically disqualified from preferential tax treatment and are taxed as ordinary income.
  • When ISOs are exercised but not sold, the difference in purchase price and market price could trigger AMT (alternative minimum tax) in lieu of income tax, depending on which is higher. Consult with your tax advisor prior to exercise to determine if this will impact you.
  • Two tax “elections” — Sections 83(b) and 83(i) — may allow you to either prepay your taxes at grant or defer paying the income tax for up to five years, depending on the type of equity awards you have. Check your plan to see if these elections are available.
  • A cashless same-day sale would exempt you from a FICA tax.

Taking the next step

Understanding how employee stock options work is the first step to determining what to do with your employee stock options after your employer goes public. Whether you decide to cash out now or hold on to shares for the long term, this is your opportunity to pursue the strategy that best meets your needs and may help to minimize taxes and potentially maximize your gains.

Deciding if, when and how to exercise your options is complicated, so consult your wealth manager or financial planner to make sure your strategy aligns with your financial goals. Continue to look even further ahead, so that you’re prepared to navigate life’s financial stages, from your company’s IPO through retirement.

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.