If your company is planning to go public, you have a lot of preparation to do. You’ll need to decide whether and how much to invest in your company before its public offering and understand the potential tax consequences of the decisions you make. The two ways companies most often make their debuts on the public market are by IPO or SPAC acquisition. The route your company takes will affect the timeline as well as the amount of volatility you can expect at public offering.
What is a SPAC?
A special purpose acquisition company (SPAC) is essentially a blank-check company whose sole purpose is to acquire another company. The SPAC first organizes its own IPO to raise funds for the purchase. It then has two years to identify a target company and get shareholder approval to acquire it. If the SPAC fails to do so within two years, it is dissolved and must return the money it raised to investors.
What happens if a SPAC acquires my company?
If a SPAC targets your company for acquisition, it will negotiate a fixed valuation with your company prior to the public offering. As a result, the SPAC process involves less volatility at public offering than in a traditional IPO. In a SPAC acquisition, things can also move pretty quickly. The process can often be completed in less than six months.
Once complete, your company will merge with the SPAC and take on its public listing, and the SPAC will no longer exist. This process is commonly referred to as “de-SPACing.” When your company merges with the SPAC, any shares or options that you hold will likely undergo conversion. This may mean that you end up with more or fewer shares than you originally owned, but the dollar value will be the same. (For example, you might own 10,000 shares valued at $5 each and end up with 5,000 shares of the newly merged company that are valued at $10 each.)
Whether your company goes public via SPAC or IPO, you can expect to be subject to a lockup period immediately following the public offering. During the lockup period, pre-IPO shareholders are prohibited from selling their shares. This is important to understand and anticipate, since it represents a substantial delay in seeing a return on your investment. The lockup period following SPAC acquisition is determined in negotiations between the SPAC and the target company, but timeframes of six months up to a year are typical.
How is the IPO process different than a SPAC acquisition?
The traditional IPO process is both longer and less predictable than a SPAC acquisition. The reason is that the IPO journey requires a company to raise funds from many different sources and conduct the entire process itself rather than having it handled by an acquiring company. This involves a roadshow to pitch the IPO to investors and conducting multiple funding rounds. Additionally, because the market determines share value in a traditional IPO, employees have much less certainty about how much their investment will be worth when the process is complete.
After the roadshow, executives and bankers consider the input they received from investors to determine how many shares will be sold to whom and at what price. Shares become available on the public market the following day. For most companies, the entire IPO process takes around 18 months, but very well prepared companies may get it done in a year or less, and timelines up to three years aren’t uncommon. On the other hand, the lockup period tends to be shorter for traditional IPOs than for SPACS, typically ranging from three to six months.
How should these differences affect my planning?
Whether your company is going through the traditional IPO or the SPAC process, it’s wise to get started on your investment and tax planning as soon as you’re aware of your company’s plan to make a public offering. If you’re anticipating a SPAC acquisition of your company, however, the shorter timeframe and longer lockup period make this much more critical. Getting started right away will help you avoid missing out on important opportunities to get more out of your investment. When making pre-IPO financial decisions, be sure to work with a trusted fiduciary advisor with experience in the IPO process. Many of the choices you’ll make are complex, and choosing wisely requires a thorough understanding of the process and associated tax issues.
Early Exercise & 83(b) Election
If you have stock options, determine whether your company allows employees to exercise their options early. Doing so and filing an 83(b) election with the IRS sets the fair market value of your shares at the time of exercise rather than at the time they would vest. If your company completes a successful IPO, then this could significantly reduce your tax liability. This move also carries risk, however. If your shares lose rather than gain value after early exercise, then you won’t be entitled to a return of any taxes you overpaid.
Once the lockup period has expired, you may also be subject to blackout periods. Blackout periods prohibit trading of shares by those who possess material nonpublic information about a company. These are often imposed ahead of earnings reports. If you frequently have this type of information about your company, a 10b5-1 plan can help you avoid unnecessary disruptions in your ability to trade your company shares. A 10b5-1 is a legally binding document that provides a detailed outline of planned trades, which company insiders make at a time when they do not have access to material nonpublic company information. By detailing planned trades in advance, these shareholders avoid any appearance of insider trading. As a result, the preplanned trades may go ahead regardless of blackouts.
The tax implications of IPO are complex. How and when you will be taxed depends on several factors, including the type of shares or options you have, how long you own your shares, and your company’s size and operations. It’s important to find a tax advisor who has experience with the IPO process so they can make sure you’re aware of all important deadlines and the tax consequences of your financial decisions. It’s critical to line up a tax expert early in the process so you can plan for any spikes in taxable income that occur before you’re allowed to sell. You don’t want to receive a surprisingly large tax bill that you’re unprepared to pay! Your advisor can guide you to sources of funding, such as loans, that you may be able to access for this purpose.
WRP specializes in providing financial, investment, and tax advice to executives and employees in pre-IPO companies. For more tips on getting ready for your company’s IPO or SPAC acquisition, subscribe to our blog.