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🤑 Your company IPO'd…now what??

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In our last newsletter, I discussed the logistics of an IPO at a high level. Now that you (hopefully) have a better idea of what goes into a company going public, I wanted to focus this week on the decisions employee shareholders have to make when they’re fortunate enough to be in an IPO. An IPO can generate life-changing wealth, so it’s pretty important not to screw it up.

Many have likely not put this top of mind over the past year or two as IPOs screeched to a halt, the markets were volatile, and valuations dropped. But now that we’ve had three major IPOs in the last week, two of which were heavily anticipated VC-backed companies — Instacart and Klaviyo — many other companies are likely to set their sights on an IPO in the near future.

And, yes, we will be sharing some of our thoughts and analysis of this week’s IPOs next week…but our first thought is: It’s too early for any major takeaways! So stay tuned….

For those that may find themselves with equity in a soon-to-be public company, I wanted to share some tips and insights on how to be prepared. This is not meant to be exhaustive, and it’s not meant to overwhelm. It’s meant to light a fire under you so you’re prepared.

Many people may think that the outcome of their equity ownership is out of their hands. This is only partially true, there are many decisions you can make that will impact the outcome. It’s important to know what those are and how to approach them. And your decisions don’t stop when the company IPOs. 

If you find yourself asking these questions already, or want help answering them, feel free to put some time on my team’s calendar.

🙋 Questions to ask before the IPO

We talk a lot about what happens before an IPO but I wanted to retirate it here because: 1. It’s important and 2. I wanted to help visualize it in a simple format here.

A lot of people at startups have put off making decisions about their equity for understandable reasons — IPOs have been nearly non-existent and valuations have been down. Many probably think, “I’ll wait out the storm.” But not making any decision is a decision and may pigeonhole you! It’s better to be proactive than reactive.  You don’t want to be forced to make decisions that are either not informed or less-than-ideal.

An obvious example is if you leave your company, or are let go. You’ll have to make a decision about what to do with your equity. And the company may be a great one — despite your personal feelings about leaving. Not being backed into a corner is a major reason to get ahead of your equity, but really it’s about creating flexibility to get the most out of it if, and when, an exit event happens.

So here’s what to start thinking about now:

1. When should I exercise my options?

Generally, exercising earlier rather than later can save you tens of percentage points in taxes. But it also carries risks too — a later stage company is more likely to exit than an earlier one, for obvious reasons. You have to weigh the risks and benefits and make a decision that is best for your family.

2. Where should I get the money needed to exercise?

Should I self fund it or finance it? If I’m coming up with the cash myself, where should I pull it from? What part of my portfolio should I sell to generate the funds for the exercise? Does it make sense to tap retirement assets to exercise?

Taxes, portfolio diversification, and investment strategy will play a role in the optimal decision.

3. If I have the opportunity, should I sell any before the IPO?

Maybe your company offers a tender, maybe there’s a secondary market for your shares, or maybe you’re able to get financing that offers you liquidity. Should you take it?

Well, it certainly depends. Your cash flow situation and balance sheet will matter as will the “moneyness” of your options and the company’s plans/likelihood of an exit.

It’s often a good idea to diversify, when given the opportunity, but you’ll also want to look at how much you should sell and from which grants in order to manage taxes and set yourself up for potential future gains.

🏃 Questions to ask and decisions to make during/after the IPO

It’s easy to think the IPO is the end of the road. Yes, it is a major milestone but it’s hardly the end. For all the collective sighs of relief from Instacart and Klaviyo employees — their shares are now liquid! — they’re at the beginning of another set of consequential decisions.

Yes, when to sell is a major one. But there’s quite a bit more to it than timing the sale. It’s ultimately about what the windfall means for your life. How will you use this event to achieve your financial goals? Whether that’s buying a house, planning for retirement, or taking an extended sabbatical to figure out your next career move. At the end of the day, the IPO is the moment when things get real. It can be easy to view it as a lottery ticket: you get some cash or you don’t. But really, it’s a trigger event that means you need to start doing some serious planning, because this could be the (lotto) ticket that builds the financial foundation for the rest of your life.

Here are decisions you’ll likely need to make once your company does go public:

1. If I’m able to sell some of my stake in the IPO itself, should I?

Typically, there’s a lock up period for employee shareholders — often six months after the date of being listed, but it can vary company to company. However, there is the chance that you may be given the option to sell some earlier. Sometimes, this is based on criteria, like if the stock price increases by a certain percentage, employees can sell X% of their holdings by X date.

So, should you? Well, you’ll need to ask yourself (and your financial advisor) some questions, especially: What’s your outlook on the company? Most IPOs experience a first day “pop.” Historically, that pop has averaged 19%, but the range of potential outcomes is wide.

And also: Is the potential extra return worth the risk for you? If this event is catapulting you to a different level of financial security the decision may be different than if this event is adding to your already robust financial situation.

2. Can I and should I exercise my ISOs during the lockup period or just wait?

It’s likely that you can exercise during the lockout, but you should check the paperwork you’ve been sent from your company. Or, you can ask your company’s equity team.

Again, exercising options earlier can help you reach the holding period that makes your gains eligible for long-term capital gains status, potentially saving you a lot of money. All else equal, you want that clock to start ticking as early as possible to give you the most flexibility.

3. When the lockup expires, how much should I sell and when?

The media and financial analysts will be watching the lockup expiry like hawks. The potential supply from insider selling might mean investors will be cautious until the share overhang from the lockup is over. In other words, there is often a large number of sales when the lock up ends because employees can finally sell! This can lead to a dip in price, though often temporary.

The right decision will depend on many factors similar to those in the previous point. Often, diversifying (aka selling some) as soon as you can makes sense, especially if the stock makes up a major percentage of your net worth. The goal is to move some of that into less risky investments.

But how much you should diversify / sell and when depends on your own financial situation, as well as your outlook of the company in the short- and long-term.

4. How should I trade the stock?

When a stock trades publicly on an exchange, there is much, much more liquidity available than when it’s private. This is great because it means transaction costs are lower, valuation certainty is higher, and you can sell almost anytime you want (except when markets are closed).

Liquidity is multidimensional. A narrow spread between the “bid” and “ask” (the price you can sell/buy at) may be great for trading costs but may only apply to a limited number of shares. If you have a lot of shares to sell, you also care about the “depth” of the order book.

One way to avoid getting poor prices is to spread out your trading over time and use limit orders. Think of it this way: If a grocery store has millions of boxes of Cap’n Crunch to sell, the natural buyers may run out of demand and the store will be forced to lower prices on Cap’n to get others interested in buying. You don’t want to be selling all the Cap’n Crunch all at once, it’s better to space it out so supply and demand are more balanced.

5. Should I set up a 10b5-1 plan?

This is a way to designate a stock sale plan ahead of time so that you don’t run afoul of insider trading rules. The trading is outsourced to a third party and executed according to the predetermined plan. It’s most common for officers and directors of a company that have access to inside information

6. If and when I do sell, how much should I set aside for taxes? How should that money be invested until that payment is made?

Tax rates are different depending on the holding period, type of stock, and where you live. It can get complicated. Especially if you paid the Alternative Minimum Tax (AMT) upon exercising and want to use your carry forward credit upon sale of the stock. This is why working with a financial and/or tax professional is pretty imperative when making these decisions.

7. If I am able to choose my withholding percentage, either 22% or 37% on my RSUs, how should I decide which is best?

Do you like being surprised by bills? I don’t. With a windfall like an IPO, your tax bracket is likely going to be higher than a typical year. Are you setting aside enough to cover your tax liability? Withholding too little relative to your eventual obligation can subject you to additional risk. Withholding too much means you missed out on using those funds.

8. What should I do with the proceeds?

Ooooh, think of all the possibilities! A house? A vacation home? A trip of a lifetime? The possibilities are literally endless.

One of my favorite investing quotes is: “Don’t risk what you have and need for what you don’t have and don’t need.” If this event is establishing a baseline of financial security/freedom for you, it’s probably best not to YOLO into a concentrated portfolio and instead invest the proceeds in a more reliable and diversified way. The larger your portfolio relative to your needs, the more idiosyncratic moonshots you can take.

But until you’re set with the basics, you should diversify! What does a diversified portfolio look like? I could spend pages and pages describing the considerations for creating an asset allocation and a portfolio. For now, I’ll give you a good starting point.

The “market” is the default portfolio. What is the market? Well, it’s every investable asset possible in its proportional weight. That portfolio is impossible to own, so you have to take some practical shortcuts. For your stock portfolio, it’s all the listed stocks on all the exchanges all over the world in their proportional weights. There may be reasons to deviate from this portfolio. But if you are deviating, ask yourself why. Do you really have a good reason? The S&P 500 is roughly five hundred stocks. There are over 10,000 publicly traded companies worldwide. If all you own is the S&P 500, you’re not all that diversified in my opinion.

📖 It’s just the beginning of a new chapter…

These are just some of the many, many questions you’re likely to ask yourself, those around you, and hopefully a competent advisor. There will be others, like, “should I set up trusts for my children? And how should they be structured?”. If you’re charitably inclined, you may want to explore tax efficient giving strategies. You’ll also likely look for other ways to minimize your taxes among myriad other decisions.

One thing to remember is that these questions don’t necessarily happen once, and they don’t happen in a vacuum. A financial and investment plan — and that’s really what an IPO plan is — is a living, breathing thing. It changes when it needs to, and when you want it to.

If you change jobs, lose a job, have a child, buy a house, move to a new city, decide to angel invest, etc. etc. These are all reasons why you may need to make new or different decisions with your money.

We’re all breathing a bit easier now that we’ve seen some IPOs. But as more come (and they will at some point), employees at those companies are just entering a new phase of their equity and financial journey.

Things we’re digging:

  • 🧊The IPO market is thawing. Congrats to Instacart and Klaviyo employees! This was a big week for everyone in the startup community. Look out for my thoughts on these debuts next week, but this was a big week for employee shareholders. In fact, the Instacart CEO said employees were the main reason for IPOing. This could be a driver for many IPOs over the next few years.
  • 🚪IPOs aren’t the only exits happening. With IPOs crawling back to life, we may also start to see more M&As too. An exit is an exit! This week’s big news was Cisco buying Splunk for $28B.
  • 💰So, are we back? Well, more of my thoughts on what this means next week. But, as we’ve said before, 2021 ain’t coming back soon…which is OK!

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