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IPO Is Imminent: What’s Next?


You’ve put years of hard work into this moment. You made the strategic decision to work in technology - an industry where compensation packages require you to sacrifice current cash flow in exchange for compensation in your company’s stock - all for the promise that some time in the future, your bet would pay off. This is the year you’ve been waiting for. Wall Street is aflutter with news of the impending IPO. This article is all about how you, senior employee at XYZ company about to IPO, should prepare yourself for what’s to come. It’s also for any employee who is compensated with company stock.

Over the past few years, technology companies have chosen to stay private longer. Private companies tend to have more control over the business, but have a harder time raising capital. Institutional investors (think venture capital and pension funds) have filled that void by providing an influx of money into these companies. In that time, private companies have grown to unprecedented sizes - we are in the age of private tech unicorns. In 2019, the dynamics have changed. Some of the largest tech unicorns have decided to go public, which means employees are finally going to be given the choice to cash out.

What is an IPO?

An IPO, or Initial Public Offering, is what is commonly referred to as ‘going public’. The process for an IPO in the United States requires a private company to register with the Securities and Exchange Commission (“SEC”) typically with the help of an investment bank. Once approved, the private company may sell existing or new shares to the wider public. This creates a surge of capital for the company going public, while providing everyday people an opportunity to invest in a company that was previously inaccessible. Anyone with a brokerage account can buy and sell a public company’s stock. This is in deep contrast to a private company which is typically limited to institutional investors.

How an IPO may change your day job

Since anyone can buy a public company’s stock, the company has obligations to the investment community (and the SEC in the United States) to report financial information on a quarterly basis. Investors expect transparency when it comes to filing (remember Enron?) and accounting standards dictate how companies are required to report. Since the investment community is relying on quarterly data to make assumptions on how the company is doing today and growing in the future, these short term numbers can have a much larger effect on the company’s valuation and stock price. Managers and employees within the organization will have to consider not only the longer term vision of the company, but how the company will continue to meet its goals each and every quarter.

Both revenue and expenses matter, so having an understanding of where you fit into that picture as an employee is important. As a private company, owners of the company were likely limited to a handful of institutional investors, but after going public, the company may undergo scrutiny from a larger group of individuals. Lots of cooks in the kitchen - it’s worth understanding the ingredients of your business that make investors happy!

If you work in tech, you probably have been paid in stock

Just about every technology company employee should be familiar with stock compensation. Compensia, a compensation consulting firm, recently did a compensation study on 150 publicly traded technology companies and found that 99% of companies surveyed grant time-based restricted stock units (RSUs), 61% grant performance-based RSUs and 51% grant stock options (ISOs or NSOs). Based on our experience with employees of private technology companies, their stock compensation packages are very similar.  

As Aswath Damodaran writes for Stern School of Business, companies provide stock compensation for four different reasons:

  1. Stockholder - Manager Alignment: Managers who own stock will most likely act in a way that is accretive to shareholder value.

  2. Scarcity of Cash: Companies in a growth phase with low revenues may not have the cash on hand to pay their employees the market rate, but want to compensate them appropriately.

  3. Employee Retention: Compensation packages are typically structured over a multi-year period to keep employees for the long run.

  4. Accounting & Tax Treatment: Depending on the structure, stock compensation may receive preferential tax treatment to both companies and employees by comparison to cash compensation.

Both the employee and employer stand to benefit from stock compensation programs and the longer you stay, the more you as the employee stand to make.

Stock compensation and your bottom line

Restricted Stock Units (or RSUs) are the most common form of stock compensation and most simple in terms of understanding and tax treatment. Instead of paying you cash, your employer will pay you in stock. RSUs may be granted based on time or performance metrics and all of the details of the grant will be outlined in a Grant Document. The Grant Document will specify how many shares you will receive and over what length of time. A common case for time-based RSUs is to receive shares every quarter over a 3-4 year period.

When you receive RSUs, your company will report them as part of your W2 wages (it’s basically like cash, but you receive stock). The catch is the IRS classifies RSUs as Supplemental Income, meaning employers might only withhold 22% in taxes on your RSU-related income. This is different than the tax withholding on your salary. If you are in a higher tax bracket, a 22% withholding may not be enough and could mean you are due for a surprise tax bill at the end of the year, even if you haven’t sold the company stock.  

Once you receive RSUs, you own the company stock! If you sell them right away at the price you received them, there is no additional tax. If the stock goes up after you receive it and you decide to sell it, any growth will be subject to capital gains taxes. Capital gains are taxed at your ordinary income bracket if they occur within one year (aka short term capital gains) and at the long term capital gains rate (15-20%) if you hold them for over one year.  

Stock Options are another form of stock compensation. Stock options at their most basic form give you, the recipient of the stock option, a right but not an obligation to buy your company’s stock at a certain price before a certain date. If you decide to buy the stock, it is referred to as ‘exercising the option’.

No taxes are due when you receive the option; however, you will owe taxes in the year you choose to exercise the option. Although your company will dictate when you are granted the stock options, they do not specifically dictate when you have to exercise the option. This means there is added choice but also added complication. Options have tremendous upside and tax benefits, but because they are more complicated, there’s more to consider:

  1. The risk of putting all your eggs in one basket: You work there and you’re spending your hard earned cash to invest further in that company.

  2. The tax implications: Different types of options, for example incentive stock options versus nonqualified stock options, have different tax treatments. We recommend consulting with a CPA and tax professional on taxation of stock options prior to making these decisions, because the tax impact can be material and detrimental if not handled with care.

  3. The affordability of investing vs. the opportunity for using your cash in other places.

  4. The ability to sell the stock after you purchase it: In a private company, your stock is a lot harder to sell than in a public company.

As an employee of a tech company, you could receive RSUs or stock options or even both. In any case, the considerations of owning stock and how to evaluate stock compensation in a private company are very different than in a public company. The most meaningful difference is liquidity.

In a public company, if you receive shares from your company and you have the flexibility to sell the stock at anytime outside of certain restricted periods. The restricted periods are very well outlined and are set up to protect outside investors who might not know as much about the inner workings of a company as employees.

In a private company, you are typically bound to restrictions dictated by the founders and/or investors of the company, and oftentimes these are not as clear cut or transparent. If the existing investors are unwilling to purchase your stock and your company has not approved you to transfer or sell the shares within a private marketplace, you will most likely have to hold them until there is a liquidity event (like an IPO!).

You’ve been preparing for this moment for a long time- execution is critical

You would never go into a big surgery without meeting with your surgeon, the anesthesiologist and the nurses that are going to take care of you before, during and after the operation. Your finances should be no different.

When it comes to preparing your financial life for an IPO, your team should be comprised of an Estate Attorney, Certified Public Accountant (CPA), and a Financial Advisor (who holds a CERTIFIED FINANCIAL PLANNER™ designation). Each member of the team plays a critical role in helping you plan for your future windfall; all are essential to ensuring your plan will go off seamlessly. At Mana we coordinate these strategy sessions between all members of our client’s team before the IPO.

Your Estate Attorney will review your estate plan or help you create one if you don’t have one. They will consider the transferability of your stock options, allocate assets per your direction and will assist in the creation of a living trust. Your CPA will review your stock option agreements, calculate the tax impact throughout the IPO process, and will ultimately be in charge of your specific plan of action which will help you avoid making any costly tax mistakes. Your Financial Advisor should help you understand what’s next. Ideally, you will be advised to diversify your future net worth into a portfolio that will reduce your current exposure to your company’s stock. If you’ve already worked with your advisor to create a comprehensive financial plan, your advisor should have helped you understand the impact this sudden windfall can have on your future goals. The most important role of your financial advisor is to map out how your future liquidity will fund your biggest goals.

The power of intentions...

The day has finally arrived - you wake up, go to work, celebrate with your coworkers. When the day of the IPO arrives, the first thing you should do is celebrate. It’s taken years to get to this point. If you’ve been along for the ride most of that time, you deserve a moment to soak in the glory of your accomplishments. Next, go back to your plan. It’s easy to let emotions get the better of you. The reason why you invested in retaining a team of financial professionals is so that they could be your objective third party, reminding you of the plan you’ve already put in place. You can’t control the dynamics of the market, but you can control how you execute the plan you’ve worked (and paid) to build.