The journey through an initial public offering (IPO) and the management of one’s equity compensation can be complex and filled with critical decisions. This guide aims to provide an overview of what you need to know in order to navigate the landscape effectively.

Setting the Stage

What You Need to Know

Decision-Making Timeline

The long IPO journey reaches critical mass with the company’s confidential submission of an S-1 filing to the SEC. This document, whose filing may be leaked to the public, details the company’s financials, risks, and the intended use of capital raised from the IPO. It’s important to note that at this stage, it’s not always clear if the company will opt for a traditional IPO or a direct listing.

While a lot is happening behind the scenes, from the employee perspective, there are two primary periods of time during which you can make any decisions about your equity stake if your company is going public via IPO.

1) Pre-IPO Election Window

You may enjoy a limited period of time before your employer (or ex-employer) goes public where you face a limited set of options regarding your equity, such as making a sell-to-cover election (selling enough shares to cover default withholding, which may actually not be enough to cover your tax liability—more on that later) or perhaps a sell-all election.

Neither of these options is guaranteed to be permitted, but it’s worth noting that you have a potentially limited window of time to consider such decisions.

2) Post-IPO Lock-Up Period

Following the IPO, you’ll often encounter a lock-up period—commonly six months—during which you cannot sell your shares.

Once the lock-up period has elapsed, you will again have some freedom to make decisions about your equity stake.

However, if you’re still employed at your employer, sales of stock will typically be subject to trading windows during which insiders such as yourself are allowed to sell their stock.

Understanding Different Types of Equity Compensation

Different forms of equity compensation come with different properties. While this is not a comprehensive guide to all forms of equity compensation, I hope to touch on some of the more common forms when it comes to making decisions around an IPO.

Restricted Stock Units (RSUs)

Public company RSUs function like a cash bonus, but issued in the form of company stock.

The treatment of private company RSUs is a little more nuanced, with the biggest fundamental difference vs. public company RSUs being lack of liquidity/ability to sell them.

There are two distinct types of private company RSUs—single trigger and double trigger—but most companies issue just one of these, not a mixture of both.

Single trigger RSUs are subject to ordinary income taxation and supplemental withholding when they vest after a certain period of time. At this point, you hold actual shares which when sold are then subject to short or long-term capital gain or loss treatment based on the specifics of the sale.

Double trigger RSUs, in contrast, only convert to shares and are taxable and subject to supplemental withholding after the time-based vesting is satisfied and either the IPO date or the end of the lockup period is reached, depending on the specific terms. These shares then become eligible for sale during open trading windows.

Non-Qualified Stock Options (NQSOs)

NQSOs offer the option to buy company stock at a predetermined price, providing more flexibility over when they become taxable compared to RSUs.

Incentive Stock Options (ISOs)

Management of ISOs, which offer tax advantages if specific conditions are met*, is significantly more complex than management of NQSOs. They’re not subject to ordinary income tax upon grant, vesting, or exercise but do have Alternative Minimum Tax (AMT) and some other unique considerations, which will be explored in further detail below.

* For a sale of shares acquired through Incentive Stock Options (ISOs) to qualify for preferential tax treatment, it must occur at least two years after the grant date and one year after the shares were transferred to the employee (exercise date), ensuring any gains are taxed at a more favorable long-term capital gains rate.

Getting Clear on Your Situation

Step 1 is to get clear on your equity, which can often be ascertained via your stock compensation portal (e.g. Shareworks or Carta).

If your company doesn’t have such a portal or the information you find there is limited, consult your personal equity grant documents, the company’s equity incentive plan document, brokerage statements, and personal tax records as needed.

Here’s what you should know:

• What does your upcoming RSU vest schedule look like?
• How many options and shares do you own and when do they vest?
• What is their cost basis and holding period?
• Is cashless exercise an option for NQSOs?
• Have you early-exercised/made an 83(b) election on any grants?
• Have you held any shares for 5 years? (If so, you should see if you qualify for the Qualified Small Business Stock exclusion.)
• When can you no longer exercise options?
• If you plan to leave your employer, what is the Post-Termination Exercise (PTE) Window (e.g., 90 day window to exercise ISOs post termination) and Extended PTE Window (provision that extends termination window but converts ISOs to NQSOs)?
• What is the expected IPO price?
• What are your available elections pre-IPO?
• When does the IPO lock-up end?
• What are the trading windows post IPO lock-up?

Additionally, getting clear about your personal circumstances and assessing your own appetite and capacity for risk is key to ensuring that your company’s IPO is an event that’ll serve your personal interests:

• Current and future projected household income.
• Short- and intermediate-term cash needs.
• Your plans to stay or leave your employer.
• Personal goals.

Decision Frameworks

I’ll just say straight away that there is no singular “correct” solution when it comes to making decisions about your equity during an IPO.

So how should one think about the potential range of decisions to be made?

At one extreme is the strategy of going for the immediate payoff and immediately selling what you can when you are able to do so. This strategy is the least risky, curtailing both downside and upside risk. This immediate payoff can be used to fund personal goals, increase and diversify one’s portfolio, or some combination of the two.

At the other end of the spectrum is betting on upside and only selling enough to cover any under-withholding of taxes and possibly ISO exercises. This is obviously a more risky proposition, but may be an attractive option if you have a high risk tolerance and/or no shorter-term cash needs.

In between, there is a lot of room for setting target liquidity goals or price-based sale triggers. Depending on one’s mix of equity types and future income, there may be a lot of potential options for minimizing your overall tax burden, though any strategy anchored to current stock price runs the real risk of the stock price collapsing before you sell.

A valuable framework for such decision-making can be thinking about which regret you’d rather live with: missing out on the achievement of specific goals which you can realize now for your life, or missing out on potential upside? An admixture of these approaches is common, e.g., selling enough to cover a down payment on a house after taxes and “letting the rest ride”.

Execution

Immediate Payoff

Executing on an immediate payoff strategy is relatively straightforward.

If your employer permits a sell-all election during the pre-IPO election window, you can simply opt to make that election at that time. Otherwise, you’ll want to execute all exercises and sales of your equity once the lock-up period has elapsed.

Funding NQSO Exercises

If you have NQSOs you plan to exercise and then immediately sell, you may need to have cash in hand to cover the cost of the initial exercise.

If your company supports cashless exercise, this is a great option to consider for the immediate payoff strategy. Cashless exercise allows you to simultaneously exercise your NQSOs and sell enough of the shares to cover the cost of the exercise, taxes, and fees without needing upfront cash. This is very convenient but isn’t always an option.

There is also the option to take out a loan, such as a personal loan or a loan from a family member, in order to cover the short-term cash need. Some brokerages offer financing solutions specifically for the exercise of stock options. There also exist third-party funding companies that will offer funding in exchange for a share of the future sale proceeds of the stock, though the terms can vary tremendously.

If you already own shares in the company, some companies allow for a “stock swap” where you can use the value of some shares you already own to exercise options. This method has additional tax implications but can be a potential strategy if you’re low on liquid assets.

Bracing for (Tax) Impact

Of utmost importance in the immediate payoff strategy is ensuring that you can cover your tax liability from your payday!

RSUs and/or NQSOs

If your equity is in the form of RSUs and/or NQSOs, this calculation is a bit more straightforward. Seek out a tax calculator or a tax professional to calculate the potential tax impact of your equity sale, including projected salary, bonuses, RSU vests/sales, NQSO vests/sales, etc. for the remainder of the year.

Don’t assume that because taxes are withheld you don’t need to worry about your tax bill!

Three perhaps counter-intuitive facts to illustrate:

1. Taxes are withheld on RSU vests, NQSO exercises, and bonuses according to a different mechanism of supplemental withholding (i.e. a flat rate, 22% federally and then 37% over $1M) vs. regular withholding on salary income.
2. Taxes owed on the occurrences listed in 1 are determined in exactly the same way as regular income (there is no special tax rate for these—they are just treated like salary income!)
3. Default supplemental withholding in 1 may not be sufficient to cover tax liability in 2.

The gap between taxes withheld and taxes owed frequently occurs when one earns a significant degree of supplemental income. I see this commonly in regular W-2 employees at big tech companies receiving a significant portion of their compensation in the form of RSUs, but it is even more salient if you are anticipating an IPO and you hold significant equity in the form of double trigger RSUs and NQSOs!

👉 If your company’s plan permits the adjusting of the supplemental withholding rate, increasing this rate to the maximum is a great way to pro-actively help ensure you won’t get bit by an unexpected tax bill and/or underwitholding penalties. (Unfortunately, many plans still don’t permit this.)

If you are not able to manually update withholding, you’ll need to be a lot more diligent about calculating your tax liability and meeting your tax obligations, especially as new tranches of RSUs vest!

There are various nuances around underwithholding penalties that are not in the scope of this post, but what you should know now is that the IRS has established safe harbor guidelines that, if followed, protect taxpayers from penalties for underpayment of estimated taxes. These rules are designed to provide a measure of predictability and security in tax planning, especially when your income fluctuates.

You can meet the safe harbor requirement (and avoid underpayment penalties) for 2024 by paying:

• 90% of 2024’s tax liability, or
• 100/110% of 2023’s tax liability*

*If your adjusted gross income was $150,000 or less in 2023 (or $75,000 or less if married filing separately), 100%. Else: 110%.

Given your IPO is likely to create a greater tax liability in the current year than the previous year, meeting the safe harbor based on the previous year’s tax liability is usually easier (besides also being easier to calculate).

Most states have their own underpayment penalties and safe harbor provisions (often with a structure identical to the federal system), but the specifics will vary from state to state.

For taxes you’ve calculated to owe beyond the requirements of the safe harbor rule, I typically recommend one of two strategies:

1. Paying the calculated taxes immediately, or
2. Setting aside the funds in a high-yield savings account earmarked specifically for the tax bill so you won’t be tempted to touch it.

👉 If you have RSUs that are set to vest after the IPO in the same year, I’d highly recommend iteratively re-calculating your tax liability on each vest to ensure you’re still on track and have adequate funds set aside for the tax bill!

ISOs

If you also hold unexercised ISOs, calculating your tax liability becomes a bit more tricky with the potential for AMT impact, which still exists even if you immediately sell them after exercising. AMT calculators do exist if you would like to run the numbers for yourself in parallel with ordinary income tax calculators, though if you are at risk of incurring significant AMT liability, it might be worth consulting with a fiduciary financial advisor and/or tax professional (preferably an EA or CPA) well-versed in equity compensation to ensure you don’t make any mistakes and to co-determine a longer-term plan in light of the potential AMT credits you will be generating in the year of exercise.

General Advice on Managing a Windfall

Congratulations, you’ve managed to secure your “bag”! Your potential for life transformation is vast with new resources at your disposal. And yet, it can be easier than you’d think to squander the opportunity!

I would highly recommend this guide to managing a windfall on the Bogleheads wiki, which is always the first resource I like to share when I see this topic come up:

Bogleheads Wiki: Managing a Windfall

Betting on Upside

Executing on a betting on upside strategy can also be relatively straightforward.

As with executing on an immediate payoff strategy, of utmost importance is ensuring that you can cover your tax liability from the IPO!

If you are planning to bet on future upside, this would imply that you do not intend to sell any stock in the year of the IPO, excepting possibly covering tax liability.

You might ask: how can the IPO cause any additional tax liability if I plan to bet on upside and don’t plan to sell any stock? Primarily through:

1. If you hold double trigger RSUs, these will become taxable as ordinary income and subject to supplemental withholding at either the IPO date or the end of the lockup period, depending on their terms, and
2. If you have unvested RSUs that are scheduled to vest after the IPO, these will generally be immediately taxable as ordinary income and subject to supplemental withholding when they do vest.

If your equity consists of RSUs and/or NQSOs, your tax liability calculation is a little more straightforward. Reference the prior Immediate Payoff section for more info on this.

For the betting on upside strategy, there is additionally the tactical decision around which shares to sell if you need to sell shares in order to cover your tax liability. Generally from a maximization of potential upside perspective selling shares with the highest cost basis (e.g., RSUs that vest on or after the IPO) will allow you to pay the least taxes and retain the most equity for better and/or for worse.

ISOs

If you also hold unexercised ISOs, you additionally face the question of whether you should exercise some or all of them in order to start the clock on qualifying for long-term capital-gain treatment and/or spread out the potential AMT impact across different tax years.

Calculating your tax liability is a bit more tricky with the potential for AMT impact, which exists whether or not you sell them after exercise. AMT calculators exist if you would like to run the numbers for yourself in parallel with ordinary income tax calculators, though if you hold a lot of unexercised ISOs as you approach IPO, it may be prudent to consult with a fiduciary financial advisor well-versed in equity compensation to help you calculate the potential impacts of various strategies across a range of outcomes and to co-determine a longer-term plan.

A few important factors to consider if you want to think through these decisions on your own:

1. When will specific exercised ISOs qualify for long-term capital gains treatment?
2. How much AMT am I going to incur and if so, do I have a plan in place to utilize the acquired AMT credits?
3. To what extent do I want to use vesting RSUs to fund ISO exercises? (Increased ordinary income incurred by RSUs vesting permits you to exercise more ISOs before incurring AMT).
4. Consider the $100k rule if considering early exercise. (Cumulative vest value in a calendar year beyond which ISOs are converted to NQSOs and lose favorable tax treatment).

Target Liquidity

In between the two extremes of immediate payoff and betting on upside, there is a lot of room for setting target liquidity goals or price-based sale triggers. Depending on one’s mix of equity types and future income, there may be a lot of potential options for minimizing your overall tax burden, though it is important to note that any strategy anchored to current stock price runs the real risk of the stock price collapsing before you sell. Frankly, navigating your decisions post-IPO involves a fascinating blend of planning, technical expertise, and luck!

My personal preference is for anchoring equity sale decisions to specific goals. By tying sale decisions to personal financial goals, you ensure that your actions directly contribute to achieving your broader financial and life objectives, whether it’s funding a significant purchase, such as a down payment on a house, securing a nest egg for retirement, or having enough cash in hand to fund a career break and/or change. This approach helps prevent decisions based purely on market conditions or emotional reactions to stock price fluctuations, which can lead to missed opportunities or increased financial risk.

To do this, you’ll need to get clear on your specific goal(s) and then run the numbers on which sale strategies will result in the net-of-tax proceeds you desire. Similarly for price-based sale triggers, you’ll want to run the numbers and model scenarios in order to assess the various outcomes, ensure you meet your tax liability, and maximize your personal calculus of net-of-tax proceeds and upside potential.

If your equity consists of RSUs and/or NQSOs, calculating your tax liability and potential net-of-tax proceeds is a little more straightforward. Reference the previous Immediate Payoff section for more info on performing these calculations. As I point out in that section, if you have RSUs that are set to vest after the IPO in the same year, I’d highly recommend iteratively re-calculating your tax liability on each vest to ensure you’re still on track and have adequate funds set aside to pay the tax bill!

To the extent you target a specific number for net-of-tax proceeds and include in this assessment the impact of RSUs vesting post-IPO, you’ll have to consider the potential that these vests could occur at a much higher or lower price point and adjust your strategy accordingly based on the degree you prioritize your goal achievement and the degree to which you are willing to bear the risk of these targets not being achieved.

ISOs and Held Shares

If you hold unexercised ISOs or actual shares of stock and plan to execute on a “middle path” strategy, you face additional questions, such as:

• How many/which ISOs can I exercise without incurring AMT?
• How many/which ISOs should I exercise in order to start the clock on qualifying for long-term capital-gain treatment?
• How many/which ISOs should I exercise and immediately sell?
• How many/which shares of stock should I sell given potential for varying costs bases and eligibility for long-term capital gain treatment?
• Have you/will you have held any shares for 5 years or more? (Potential qualification for Qualified Small Business Stock exclusion)

Admittedly, a full guide to answering these questions is beyond the scope of a blog post and each “optimal choice” will involve a great deal of personal preference when choosing among the various potential paths.

The more you have a mix of equity types, especially ISOs, the more strongly I’d recommend you consult with a fiduciary financial advisor well versed in equity compensation to help you understand the tax implications of exercising and selling differing lots of RSUs, ISOs, NQSOs, and shares and to co-create a plan together. I touch on some of the factors you would want to consider in the prior Betting on Upside section.

Preparing Yourself Mentally

Whatever strategy you choose to employ, be advised that planning around stock price is always rife with risk! Whatever prices you anchor to may not be reached ever again… or they may linger far below your expectations only to rocket up again years later.

Managing your emotions during the highs (and/or lows) of an IPO and the company’s first year or two as a public company can be a challenge, especially if you are still working at the company and surrounded by other people who are have their own emotions about it. You’ve likely heard stories of lowly staff becoming overnight millionaires due to holding onto company stock for a long period of time. The FOMO is more extreme when you are constantly surrounded by others who reinforce it.

Getting clear on your priorities and your goals will help you navigate this space emotionally, but we are only human after all…

Conclusion