When you’re working for a startup and receiving equity compensation, hopes can run high at IPO time. Often, pre-IPO employees enjoy sizable boosts in their wealth after their companies go public. When things don’t go as planned, it can be hard to let go of the hope that the shares will bounce back and ultimately pay off. Fear of missing out on that rebound can further fuel employee shareholders’ tendency to hang on to poorly performing assets.
If your equity compensation has fallen below its IPO value, it’s important to approach the situation with cool clarity. Neither panic selling nor relentless optimism is going to serve you here. To help illuminate the path forward, this article will discuss several factors to consider when your company shares drop below their IPO price.
Understand what kind of stock you have.
The first thing to do is take inventory of your holdings. You may have more than one type of stock in your company and/or a different cost basis in different groups of shares. It’s important to understand your losses—as well as any gains you may still have—at the current share price.
Restricted Stock Units
For example, if you have restricted stock units (RSUs), your cost basis in those shares for tax purposes is equivalent to the compensation reported on your W-2 at the time of vesting. This is the same as the stock’s fair market value at that time. In the case of double-trigger RSUs, vesting typically occurs at IPO. When the fair market value of those shares drops below the IPO price, their owners experience a loss for tax purposes.
Stock Options and Restricted Stock Awards
It’s also possible that you have stock options or restricted stock awards (RSAs). Often, employees can reap tax benefits by filing an 83(b) election. This makes the paper gain on the bargain element (the difference between the strike price and the fair market value) of these forms of equity compensation taxable earlier, when it’s likely to be lower.
- In the case of RSAs, employees have up to 30 days after the grant date to file an 83(b) election, and the gain is determined based on the shares’ value at the time the election is filed.
- With stock options, shares must first be exercised early, and the 83(b) election must be filed within 30 days of exercise. The gain on these transactions is based on the fair market value at the time shares are exercised.
Particularly if you filed an 83(b) election, a share value that dips below the IPO price—even significantly below—could still reflect gains. It’s important to understand how these gains are taxed (and whether they’re taxable at all). This depends on the specific type of equity compensation you received and whether you’ve met the relevant holding periods before selling.
Assess your current tax picture.
While a drop below IPO price is never really welcome news, it’s critical to take a clear-eyed look at your situation so you can take advantage of any potential silver linings. As you may have a mixture of capital gains and losses (both from your equity compensation and from other holdings), take stock of these gains and losses with an eye toward the potential for tax-efficient trades. There may be opportunities to offset taxable gains by selling shares while the price is low to harvest those tax losses. A trusted investment advisor who partners with experienced tax professionals to provide combined tax and investment planning can best assist you with this.
Release emotional attachment to your shares.
Especially if you’ve been with a company from its early days, it can be easy to become emotionally attached to your equity in that company. Employees often feel a proud sense of ownership in what they have helped build and hold a sense of optimism that their efforts will eventually pay off in the form of large gains in share price. To protect the fruits of your hard work, however, it may be necessary to let go of some of those high hopes.
It's true that sometimes, it works out well for employees to hang on to low-performing shares. Early employees of Amazon can certainly attest to this. Those who held on throughout the dot-com crash of the early 2000s, which saw Amazon’s stock price fall more than 90 percent, were rewarded handsomely. However, this is far from the norm. It’s important to acknowledge the very real possibility that your company’s share price won’t bounce back. This is another area in which it’s critical to have an investment advisor you trust. They can give you a professional assessment of the potential for your shares that’s based on hard data and industry experience.
Work with the right advisor.
When you receive equity compensation and your company approaches IPO, your investment and tax planning needs become more complex. At this time, it’s important to seek an advisor who is well versed in the IPO process as well as the wide variety of tax consequences employees face as they buy and sell shares of their company’s stock. You need someone who can deliver complete wealth management to protect your gains, avoid unnecessary tax liability, and design a research-backed strategy to help you reach your financial goals.
WRP Wealth Management specializes in guiding employees through the IPO process and beyond. For more tips on making the most of the opportunities your equity compensation provides, subscribe to our blog or visit our complimentary resource center.