According to the Wall Street Journal and other sources in the financial media, the IPO boom of 2019 still has staying power. For many founders and employees of the companies going public — not to mention the venture capitalists who provided their startup funding — the prospect of cashing in from a successful initial public offering is enticing, indeed.
But for many, and especially for non-E-suite employees, that IPO payday can raise lots of questions. Here are a few basics about what you can expect, focusing on your equity compensation from the company and some of the choices you’ll need to make in order to take maximum advantage of your newfound — and hard-earned — wealth.
1. Company stock
This is perhaps the most common form of employee compensation when a company goes public. Based on a vesting schedule determined by length of service, seniority, and other variables, your company may award shares of the company’s newly issued stock, making you, along with the other shareholders, one of the owners of the corporation. In the IPO, shares are offered to outside investors at the predetermined offering price, and the stock begins trading publicly. This means that you are now the owner of a valuable asset. The company, meanwhile, uses the funds raised from the offering to expand or otherwise finance the business. As the company continues to prosper, the shares of stock will increase in price. As a shareholder, you also have voting privileges concerning election of company leadership and other important matters.
Of course, stock ownership also carries risks. For example, there is no guarantee that the company will always be profitable. In the event of bankruptcy, stockholders are at the end of the line when assets are liquidated to satisfy creditors. The higher risk of owning stock, however, is compensated by the much higher historical rate of return on stocks (equity) as compared to bonds (money loaned to the company).
2. Stock options
A stock option represents the right to purchase stock at a set price. Sometimes, companies will award stock options to employees, rather than making an outright allocation of stock.
The important things to know about stock options are:
- the “grant price” or “strike price,” which is the stock price at which the option allows you to purchase the stock (or “exercise the option”); and
- the option period, which is the time within which you are allowed to exercise the option.
For example, if you have stock options that give you the right to purchase company stock at $50 per share, you might want to exercise those options if the stock were trading at a higher price — say, $100 per share. Your option would be valuable, because it gives you the ability to buy stock at much less than the current market value. As you can see, there is some strategy involved in deciding the right time to exercise your option.
3. Lock-up period
Many companies will establish a lock-up period in connection with an IPO. The lock-up period is a time during which those who receive stock in the company — especially company insiders like CEOs, venture capitalist investors, and other company leaders — are prohibited from selling their stock.
The reason for the lock-up period is to prevent persons with large blocks of shares from “dumping” newly issued stock on the market, which would typically depress the price of the stock. If your company is making an IPO, it’s very important to know if there is a lock-up period and how long it lasts.
4. Tax considerations
Good tax advice is essential to anyone receiving stock or other equity compensation in an IPO. This is especially true for those considering the sale of some or all of their newly issued stock.
Tax laws treat different types of income from sale of company stock in various ways, and you need to know the tax ramifications of each of these methods before you sell your stock or exercise your stock options.
If there is an IPO in your future or that of someone you care about, be sure to sign up for our upcoming webinar, “IPO Millionaires: How to Make the Most of Your New Wealth.” We’ll be doing a deep dive on the topics above and answering many other questions that our clients have asked over the years as they face the opportunities and responsibilities that go along with their new status. You can register for the webinar here.
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