“Sure,” you thought, when you started working for your company. “These stock options are probably a good idea… but I guess we’ll just wait and see if they turn into anything.” You didn’t necessarily think you’d become an IPO millionaire.
But fast-forward a few years, your company has announced their IPO, and…. WOW! ???? Based on the expected share price, you’re sitting on $5 million.
FIVE. MILLION. DOLLARS.
What?!?
That is some serious cash.
You’re a newly-minted IPO millionaire, and it feels really, really good.
Besides meeting some more immediate financial goals like paying off your debts and buying a house, you’re more than likely going to have enough cash left over to do A LOT more than that too… which is why it’s probably a good idea to sit down with a financial advisor and make a multi-year plan to maximize what you have, so you can really get as much runway as possible out of that money.
First Things First: Get Ready for the Taxes of an IPO Millionaire
I know, I just threw a wet blanket on this basically-winning-the-lottery situation, but taxes are a fact of life.
Unfortunately, $5 million can quickly turn into not $5 million after the tax bill is paid, so it’s better to be aware of that fact now (& prepare for it) than to be shocked by it later.
In the best-case scenario, that $5 million is taxed at the long-term capital gains rate of 23.8%, which equals $3,810,000 that you get to keep.
If it gets taxed as ordinary income, though, you’re looking at a 37% tax rate, or keeping only $3,150,000 of that original $5 million.
Add state income taxes into that, and your $5 million payday can turn into just $2.5 million to $3 million.
Don’t get me wrong: $2.5 million is still a lot of money… but not preparing for taxes first could really screw you over financially in the long-term.
Make sure you keep a tab on taxes and the changing stock prices… because you could very well end up with less than $5 million. (Though, if the stock does well, it could also be more than $5 million.)
Be able to adjust your expectations, don’t get attached to a number, and try your best to avoid the euphoria of feeling rich. This is something you’ll be working on and with for years to come, so prepare yourself mentally for that.
Second: Prepare Your Multi-Year Plan
When you’ve got this much money wrapped up in stock options, you probably won’t want to cash everything out immediately. This way, you can keep as much money post-tax as possible.
Like I pointed out in the situation above, the difference between regular income tax and long-term capital gains tax was hundreds of thousands of dollars added to your net worth if you’re willing to play the long game as a newly-minted IPO millionaire. (+ $660,000 to be exact)
Depending on how well your stock does and how many stock options you have, it could be worth $1 million or more to play the long-game instead of the short-game for your post-IPO wealth.
Needless to say: it’s worth it to take your time.
Third: Get Your Financial Documents Organized
From my experience in working with tech and startup employees, I notice that most companies cycle through several different systems that keep track of their employee’s stock options over the years before their IPO.
This can get pretty complicated to sort through, and it’ll be up to you and your financial advisor to make sense of it all.
Once you have all your records together, then it’s a good idea to organize what you have based on type of equity.
- For stock options, organize them by whether they’re ISO (incentive stock options) or NSO (nonqualified stock options), their exercise price (from low to high), whether they’re vested or unvested, and their expiration date.
- Organize your RSU (restricted stock units) by whether or not they’re double-trigger and how many of those will be released upon the IPO. Furthermore, which ones are vested and unvested? And which unvested ones will begin vesting monthly or quarterly once the IPO happens?
- Organize your shares based on how they’re treated for tax purposes. Do you have any QSBS (qualified small business stock) that have met the five-year holding requirement? Any that qualify for long-term capital gains? Short-term capital gains?
- For each of these types, organize them by lot (the day they were exercised), and by cost basis, keeping an eye out for adjusted cost basis.
Finally, you’ll want to organize your tax items:.
- If you’ve exercised incentive stock options in the past, you may have some MTC (minimum tax credit) you can use in your favor to pay less in taxes.
- Do you have any shares that almost meet the QSBS (qualified small business stock) requirements? Make note of that date, and make sure not to sell those shares before the holding period is met. If they have met the holding period, you’ll need documentation showing the date the shares were purchased, the company’s value at the time, and the date after which the company was no longer considered a qualified small business.
- Pre-IPO, you may not have many capital loss carryovers to deal with, but after it happens, you may have some of it, depending on how the stock performs. (For example, if you have a lot of RSUs that release on the IPO date, but the stock doesn’t perform well and the price goes down, you’ll have an unrealized capital loss to deal with.)
Fourth: Set a Target Price to Sell At
What you do here is pick a price that you’d be happy to sell your options, shares, and equity at either now or in the future. After all, you might be an IPO millionaire with your equity, but you can’t actually do anything with that value until you sell your equity and have that cash in the bank. To help you pick a price, think over these questions:
- What did you think the price might be someday… When you first started working there?… Last year what did you think the price might someday be?
- What were the early expectations for the IPO?
- Given the current stock price… what would be a fair price for you to sell at that you’d be happy with?
Once you set your target price, you will sell any time the stock is at that price within an open trading window and you’re allowed to sell.
Keep in mind though, it’s totally okay to change your target price. You don’t have to “officially” set it in stone anywhere, and you are 100% allowed to change your mind based on how the stock performs. After all, the stock price will be changing every minute of every day the market is open, so you’re allowed to adjust your expectations based on that.
If it does well, consider raising the target price. But if the stock goes down and stays down, that’s a good signal it’s time to adjust your target price too. Waiting forever won’t serve you, and it’s definitely better to get some cash than no cash.
Fifth: Calculate the Percentages of Your Net Worth & What Your Targets Are
What percentage of your net worth is in stock options and equity?
A lot of times, especially with an IPO, you’ll find a lot of your net worth is tied up in stock options, shares, and company equity… which can either be a good thing or a bad thing. It’s definitely better to have that net worth than to not have it, but just as quickly as a stock price can go up, it can go down that much faster, plummeting your net worth.
One of the main goals of creating a years-long financial plan on what to do with your stock options is to move large percentages of your net worth (some people start at as much as 95% or more) out of your company equity and into a more diversified portfolio. We could get it down from 95% to 75% then to 50% and then finally to 25%, and hold there as long as you feel comfortable or decide you want to liquidate completely.
Sixth: Prioritize What to Sell
When you’re prioritizing what to sell, there are two main things to take into consideration:
First, you’ll want to prioritize what you sell based on minimizing the taxes you’ll have to pay. After that, the second consideration is removing career restrictions.
To minimize taxes, this is the order you’ll want to sell in:
- RSU (restricted stock units, especially as they vest)
- As soon as these shares are released, they’re taxed on your ordinary income rate, and capital loss offsets allowed are very limited. Keep these #1 on your priority list to sell.
- QSBS (qualified small business stock)
- These can qualify for 100% exclusion on capital gains tax, and there’s nothing better than a 0% tax rate.
- LTCG Shares (long-term capital gains shares)
- These have been held for a year or more, and will be taxed at a lower rate compared to your ordinary income.
- NSO (nonqualified stock options)
- These are taxed as ordinary income, but you get to control the timing of them, unlike RSU.
If you’ve been given a stock option package that’s worth $5 million, chances are you’ve got a super valuable skill set you could take to another company and possibly get a bigger and better stock option package, so you want to remove career restrictions from your available stock options.
To do this, we sell and exercise the portions of your equity that depend on your continued employment with a company or that would require an immediate exercise if you were to leave. You want to free yourself up as much as possible.
The first one here is to exercise and hold your ISO (incentive stock options), and then exercise and sell your NSO (nonqualified stock options).
Seventh: Map Out Your Plan
After you’ve set your target price and you have an idea of what you’ll sell first, you need to think about your time frame you want to have your plan executed in. To do this, fill out the statement, “I believe the company will be worth $___________ in ____ years.” From this, you can deduce the time frame you want to commit to.
Let’s say you choose a five-year time frame. In that time, you’ll have up to 20 different trading windows. (4 trading windows per year x 5 years = 20)
If your goal is to get your company equity down to 20% of what it is currently, you’ll need to sell 80% of your equity over five years’ time. To do this, you’ll be selling approximately 4% of your company equity in each trading window.
As you’re liquidating your equity, you can work with your financial advisor on what else to do with that money to reach your other financial goals.
Buying a House Post-IPO: A Word of Warning
This is something A LOT of my clients end up doing around an IPO, and I fully support them in this decision.
HOWEVER… a lot of people get tempted to up the price of the house they’re looking for just because the net worth goes up due to their stock options. DO NOT DO THIS.
Remember: taxes need to be accounted for. Just because you’ve made $5 million does not mean you get to keep all of that $5 million.
Also, the stock price could change (read: go down), and you’ll have a lot less money than you planned for. I repeat: DO NOT base the price of your house on your stock options. Instead, wait to see how things play out. There’s no need to rush. Take some time to work through your stock options and get that cash in the bank before you make any moves with it.
Then, when you do buy a house, buy it based on your annual income (salary + bonus + annual vesting RSU), not on how much you made from the IPO. In high-priced cities like San Francisco or New York, the home target price there is around 4x your annual income, and 3x your annual income for anywhere else.
Eighth: Put Your Plan Into Practice
Let’s say that in the first trading window after the IPO, the stock is trading at or above your target price. Because you’ll get the money you need out of the sale, you’ll sell 4% of your equity, starting at the top of your priority list.
But then let’s say you get to quarter two, and the stock price has dipped below your target price. If it hasn’t dipped too far below it, you may still choose to sell. But if it’s lower than you’re comfortable with, you may decide not to sell during this trading window and wait until the next one. (Though you could still sell your vested RSU, which is typically a good practice no matter what the stock price is.)
When trading window 3 opens and the price has gone back up to at or above your target price, now it’s time to sell 8% of your company equity: you’ll sell 4% from the window you missed due to the target price being too low, and then the additional 4% for this current window.
You keep this process going through the next 17 trading windows until you’ve reduced your net worth target percentage in company equity.
No matter what though, it’s important to stick to a percentage. This lets you sell more shares in trading windows with a higher price, and to sell fewer shares in trading windows with a lower price. Over time, you achieve a higher average sales price. (Sort of like dollar cost averaging in reverse, if you think about it.)
This example does assume that you continue working for the company while you’re offloading your equity amount… but if you quit your job and don’t have the same trading restrictions as an employee, you’d be able to move to a monthly or bi-monthly schedule instead of a quarterly one.
Final Thoughts for a Newly-Minted IPO Millionaire
First off: congratulations! ????
But in all seriousness, these are the steps we’d take with one of our clients to maximize a $5 million stock option and equity portfolio.
Clearly though, each situation is highly unique and specified. You’ll need a skilled, trained financial planner to get you the most bang for your buck while working through a years-long plan like this one to make the most of your wealth.
Click here to book a client discovery call with one of our reputable financial advisors with years of experience helping people like you make the most of their stock options and company equity after an IPO.