Your company has announced its plans for IPO. Whether your company has just filed its S-1 or you just received your C round of funding, this is an exciting time full of hard work and the prospect of rich reward. While the big day might still be a while off, you have no time to waste. To make the most of this opportunity, you’ll need to start planning your investment strategy right away. Here are five tips to get you started.
1. Find out whether you can exercise your options early.
In some cases, employees and executives who receive stock options in pre-IPO companies are allowed to exercise them before IPO occurs. One of the first things to find out is whether this choice is available to you. If so, you’ll want to familiarize yourself with what this would mean for both your investment and your tax liability.
The share value of pre-IPO companies tends to be quite low. If you have a high level of confidence in your company’s success after IPO, then this could be a very attractive opportunity. The flip side, of course, is that investing in a pre-IPO company is inherently risky; there is no guarantee that the stock will have a higher value (or any value at all) in the future.
2. Consider an 83(b) election.
If you’re able to early exercise your stock options and decide to move ahead, it’s important to understand how Section 83(b) of the Internal Revenue Code could alter your tax liability. You have just 30 days after your options are granted to file an 83(b) election. Doing so makes the bargain element of your exercised options subject to the alternative minimum tax (AMT) calculation at the time they were granted rather than at the time they vest.
Because pre-IPO shares tend to have a low value, the bargain element is often very low. As a result, making an 83(b) election has the potential to significantly reduce an investor’s tax liability. However, this move also involves risk. In the event that share prices fall after an 83(b) election, you won’t be able to recoup any excess tax that you paid.
3. Understand the lockup period.
When you’re making your investment plan, it’s critical to understand that you will likely need to hold your shares for an extended period of time. After your company reaches IPO, expect your shares to be subject to a lockup period of six months or longer. Companies and their underwriters commonly include such provisions to protect share value as they make their debut in public markets. If employees were able to sell all their shares immediately, this could create a flood of supply, overwhelming demand and sending the stock price tumbling.
4. Anticipate blackout periods.
Even after the initial lockup period expires, it’s likely that your ability to sell your shares will be limited by trading windows and blackout periods. Blackout periods are stretches of time during which people who hold material non-public information about a company are prohibited from trading its shares. These are imposed to prevent insider trading and the appearance thereof. Trading windows, on the other hand, are times when company insiders are allowed to trade freely.
It’s possible to get around blackout periods by creating a 10b5-1 trading plan at a time when you are not in possession of material non-public information about your company. Such a plan allows company employees and executives to make prescheduled trades, even if they occur during blackout periods. The act of planning trades ahead of time eliminates the appearance of insider trading.
5. Work with trusted financial professionals who understand the IPO process.
The IPO process is long and complex, and you have many consequential decisions to make along the way. Investment, financial planning, and tax professionals who are experienced in helping individuals through their companies’ IPO processes are invaluable resources. A fiduciary investment advisor can help you decide whether and when to exercise stock options as well as devise a sales plan to help you maximize gains while mitigating your risk of loss. Tax expertise is also essential, as taxability can have a tremendous impact on your overall gains.
The experts at WRP and our partner, WRP Tax, have extensive experience navigating the IPO process and its tax implications. Learn more about who we are and our approach to wealth management.
