Your Employer Is Going Public. What Should You Do With Your Stock?

If your employer is the next SpaceX — private, valuable and planning a splashy IPO — your company stock may feel like a winning lottery ticket. But equity compensation is not as simple as waiting for someone to read off your numbers. The choices employees make before and after an IPO can affect how much of that wealth they actually keep. And your biggest mistake may not be missing the peak stock price. It may be going into the event without a plan.

“Employees who tend to navigate IPOs best are the ones who prepare in advance,” says Steve Moyer, a certified financial planner and certified equity professional with Mariner, a wealth management firm. “One of the things that can happen is people react emotionally to sudden wealth rather than executing a thoughtful strategy.”

Developing a plan takes time. There are details you need to gather, new concepts to wrap your head around and common traps to avoid. If you’re overwhelmed by the whole thing, consider finding a financial advisor who knows the ins and outs of going public. When the stakes are high, working with a qualified professional can be a relief.

Take stock of what you own

Employees may have multiple forms of equity compensation, and they all work a little differently. Most importantly, different types of equity compensation may follow different tax rules. That’s why Moyer says his team’s first steps involve mapping out a client’s holdings. You may have, for example:

• Incentive stock options, or ISOs. These are stock options granted only to employees, who can then purchase a set quantity of company shares at a certain price. ISOs can have preferential tax treatment.

• Nonqualified stock options, or NSOs. These are stock options with fewer restrictions (and may have fewer tax perks). Companies can grant them to employees, as well as outside service providers, including advisors, board directors or other consultants.

• Restricted stock units, or RSUs. With these, you receive a specific number of company shares, subject to a vesting schedule and potentially other stipulations. Private companies sometimes have double-trigger RSUs, which means the shares do not transfer to you until after the company reaches a milestone, such as an IPO.

• ESPP shares. An employee stock purchase plan, or ESPP, allows employees to buy company stock at a discount. Typically, participants make contributions to the plan via payroll deductions. The ESPP holds the money until a specified purchase date, and then uses the money to purchase shares on employees’ behalf.

• Common shares from previously exercised options or vested awards.

You’ll need to review any documentation or statements to gather the important details of your options, units or shares, including when they vest, what they cost to exercise, what they may be worth, how they are taxed, when they expire and whether company rules limit when you can sell.

Know when you can sell

You may have a few hurdles to clear before you can sell your shares.

• Tender offers, which are offers to buy a company’s shares, may occur before an IPO. That can be an opportunity to cash out, but it comes with tradeoffs, including potentially losing out on participating in a future IPO. In that situation, you’ll need a plan around whether you’ll participate, how many shares to sell and what the tax consequences would be.

• Lockup agreements prevent employees and other company insiders (including your friends and family) from selling their shares for a certain period after the IPO date. Typically, they last 180 days. Lockup agreements may also limit the number of shares you can sell over a given period of time.

• Company trading windows are intended to guard against insider trading. Generally, they create periods during which employees can buy or sell company shares, as well as blackout periods when they can’t. For example, you may be barred from buying or selling shares in the weeks before your company’s quarterly earnings announcements.

• Restricted securities are often shares you acquired in a private transaction and may include shares you received through employee stock benefit plans or as compensation. You may have to meet specific resale requirements before you can sell these shares, even after an IPO. You’ll need to understand any holding-period requirements, filing requirements or limits on the number of shares you can sell.

• Liquidity requirements could be significant, as well. You may need cash to exercise stock options or cover taxes from an exercise or vesting event. For example, you may owe alternative minimum tax if you exercise incentive stock options, even if you haven’t sold the shares yet. (More on AMT below.)

You may experience a lot of emotions in those early days when you can’t sell your shares, especially if the stock price experiences volatility. That’s normal, and having a plan can help keep you calm.

“Until they can sell shares, there's nothing they can do,” Moyer says. “Part of the challenge is, you know, how do we help guide them through that process and reassure them that things are going to be okay?”

» Not an employee? Find the brokers that give you access to IPOs

Watch for tax surprises

Taxes are likely the biggest reason to make a plan before you act, Moyer says. “There's a lot of different moving parts and each has unique tax implications. So it's easy to miss something or just get caught off guard.”

Here’s what to look out for.

1. Different tax treatments

Here’s a look at how taxes generally work for RSUs and stock options.

2. Inadequate withholding

A common problem with RSUs is underwithholding taxes. When RSUs vest, the IRS treats the value of those shares as supplemental income. The default tax withholding rate is typically 22% in this situation (37% if all your supplemental income adds up to more than $1 million in a year)^[0]

3. AMT

If you haven’t heard of alternative minimum tax, you’re not alone. “I’ve met with quite a few folks who’ve come to us because they exercised incentive stock options in a prior calendar year,” Moyer says. “And now they’re being told that they owe a lot of taxes because of AMT, and they didn’t even realize there was an AMT.”

AMT is a tax system that runs parallel to the standard tax system but has different tax rates and rules that are generally designed to ensure high earners pay a minimum amount in income taxes. For example, AMT limits certain breaks so that the tax bill is higher. AMT payers calculate their income tax twice — under regular tax rules and under AMT rules — and then pay the higher amount owed^[0]

Like with every tax consideration, there are strategies you can use to avoid triggering AMT or otherwise reduce your tax burden. So just because it’s a possibility doesn’t make it a certainty.

» MORE: When to exercise stock options

Decide how much company stock is enough

Having a significant portion of your net worth concentrated in a single stock can be risky. When that stock is the company that employs you, the risk can be even higher. If the business fails, you may lose your investment and your paycheck at the same time. Although you may want to keep some of the shares long-term because you believe in the firm’s future, it may also be smart to diversify your holdings so your whole financial picture doesn’t rely on the performance of one company.

Moyer says his team creates a sell plan even before all the IPO details are known. He asks clients to think through how much they would sell as soon as they’re allowed, how much they might sell over time and how much, if any, they want to hold long term. Then, as the IPO approaches, the planning becomes more granular. He pinpoints which shares to sell first, based on time held or their value; he also projects the tax liability and creates a timeline around lockups or blackout periods.

Use the IPO to update your broader financial plan

If parting with some of your shares feels hard, consider what you might want to do with the cash. Some money might go toward a short-term goal, such as a home purchase, vacation or tuition bill, for example. Some might go toward retirement savings, financial independence or another long-term goal. The point is, having a plan for the IPO dovetails beautifully with having a full-blown financial plan.

A comprehensive financial plan can cover your daily finances, debts, savings, investments, goals and other areas such as insurance and estate planning. Having these pieces in place and up-to-date is critical as your financial picture evolves.

“We're not going to just come in and recommend they sell company stock so that we can manage those investments,” Moyer says. “It all starts with their plan, their goals, their objectives, what they're trying to accomplish in life, what this wealth could potentially mean.”