While you likely have a general understanding of what an IPO is, most employees aren’t aware of the many steps involved in completing a successful IPO. Even more importantly, they may not understand how an IPO will impact their own financial lives. Below is an overview of the IPO process, as well as a look at how you can prepare yourself and your equity compensation for such a major financial event.

First, Some Terms to Know

Before we dive into the IPO process and its impact on your stock options, let’s first review a few important terms relating to your equity compensation and IPOs. 

IPO: An initial public offering (IPO) refers to the period when your company starts trading its shares on a stock exchange. Doing so enables your employer to raise capital in public markets, while simultaneously giving outside investors a chance to buy stock.

Pre-IPO: Before going public, investors (typically private equity firms or hedge funds) have the opportunity to buy large shares of company stock before it goes public. Typically, these buyers receive a “bulk” discount on the shares.

Lock-up Period: Once the company goes public, there is typically a period of time when employees and early investors are not allowed to sell their shares of company stock.

Quiet Period: Prior to going public, the SEC requires companies to engage in a “quiet period” where employees (namely management and marketing teams) are not allowed to publicly project or express opinions regarding the company’s valuation.

Vesting Schedule: The vesting schedule is the time between when an employee is granted units or shares and when they can gain ownership of them.

Understanding the IPO Process

The IPO process is typically long and extensive, lasting several months (though it could be over a year). Some companies will even wait to go public until we’re well into a bull market, to increase their odds of receiving a higher valuation.

The general journey to an IPO includes:

  1. S-1 filing: When a company decides to go public, their first step is to file an S-1, or IPO prospectus. Spanning several hundred pages, this SEC-required file is essentially a “get to know us” introduction to the public.
  2. Underwriting: An underwriter or administrator (which is usually an investment bank) will use their connections to help increase public interest and network with potential investors. This part of the process is meant to gauge what the market price may be.
  3. Investor roadshow: During this stage, the company (with help from their underwriters) will go on the road to drum up interest and try to find large buyers to participate in the pre-IPO.
  4. Establishing the terms of the IPO: Based on investor response, the company will set terms for the IPO and publicly announce their intentions—namely, how many shares they’ll offer and pricing.
  5. Going public: A couple of days after announcing their plans, the company will IPO by listing shares on a stock exchange (like NASDAQ or NYSE). 

What Is the Financial Impact of an IPO?

With an understanding of how an IPO impacts a company, let’s consider how it will affect tech employees.

The good news? An IPO can improve your net worth significantly and, if everything goes well, help set you up for a future of financial independence. 

The bad news? IPOs can bring complexity to your financial life, both in terms of tax liability and legal concerns. 

Minimizing the Tax Impact

First and foremost, work with your advisor or tax professional to better understand the potential tax consequences of your stock options or restricted stock units

Generally speaking:

  • Incentive Stock Options (ISOs): While you don’t owe taxes when exercising your ISOs, you may be responsible for paying capital gains tax if you sell your shares for a profit. Also, you could be subject to the dreaded Alternative Minimum Tax, depending on your income and the value of the ISOs.
  • Non-Qualified Stock Options (NQSOs): Your shares will typically be subject to ordinary income taxes if you do a same-day sale of NQSOs. 
  • Restricted Stock Units (RSUs): When these shares vest, it is as if you were given a cash bonus. Shares are usually withheld to cover the taxes which are at the ordinary income tax rate. When you go to sell, you may need to pay capital gains tax on the profits.

Timing: Timing is an important factor in minimizing your tax liability on equity comp. Both ordinary income tax and capital gains tax are based on your total taxable income. Waiting to exercise or sell your options until a below-average income year could help reduce your overall tax liability.

Capital Gains: Keep in mind that holding onto your shares for at least a year after they vest can save you on taxes. If you sell your shares within a year of owning them, the gains will be subject to a short-term capital gains rate—which is the same as your ordinary income tax rate. If you wait to sell for at least a year, you’ll be taxed at the long-term capital gains rate, which caps out at 20% (less than most tech employees’ ordinary income tax rate). Keep in mind – this can be a tricky aspect of ISOs. Investors should make sure they know the rules and ideal timing before exercising their options and/or selling. 

Withholding Taxes: With RSUs in particular, your employer is required to withhold some units to cover your tax liability when they vest. But for high earners, the amount withheld may not be enough to cover the total tax bill. Work with your advisor or tax professional to figure out how much extra cash you’ll need to cover the tax bill come April.

Work With a Professional: The potential tax consequences of stock options, especially before and after an IPO, are complex. We highly recommend speaking with a tax professional and your advisor to avoid unnecessary tax liability and/or penalties.

Is Your Company Headed Toward an IPO?

Remember, selling shares that have gained tremendous value after an IPO can infuse a large amount of cash into your financial life. If you don’t have a plan for how you’ll use that money to further your financial goals, you may feel overwhelmed or tempted to splurge on impulse buys. 

You should work with your advisor ahead of time to make a game plan that balances your desire to celebrate your success with your other priorities like saving for retirement, paying down debt, and building a nest egg for your family.

If you’d like help preparing your finances for a major liquidity event like an IPO, don’t hesitate to reach out today and schedule time to talk.

After a successful career in high-tech, Sheila McGinn, CFP® followed her passion and became a fee-only Financial Planner, where she helps clients navigate complex financial decisions and reach their financial goals.

Disclaimer: This content is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. For advice specific to your situation, consult a financial planner, accountant, and/or legal counsel. Reproduction of this material is prohibited without written permission from Brightview Financial Solutions, LLC, and all rights are reserved.