When a company you hold equity in is preparing to go public, has gone public or faces a major liquidity event, understanding how that IPO can impact your equity, taxes and financial plans can help you make the most of the opportunity.
You spent the last few years building a company from the ground up, or perhaps you’re a key employee. Now, an IPO is on the horizon and you’re in for the financial boost of a lifetime with equity compensation as part of your package.
Overnight, you might go from having a nice salary to holding millions of dollars in company stock. And with the IPO market heating up, including the potential for record-breaking IPOs, especially in the tech industry, these debuts create massive financial wins for equity holders.
On the flip side, equity compensation can trigger significant and immediate tax consequences. The moment equity turns into real wealth, tax decisions become more urgent. Most newly minted millionaires have little experience managing a sudden influx of wealth, and their employers typically don’t provide personal tax advice.
Without the right preparation, you’re likely to face some pretty severe tax consequences and miss the chance to protect your windfall. Here’s what you need to know and do to secure your financial future when your company rings the opening bell.
Before you can make plans for your money, you need to understand what kind of equity you actually hold. Here’s a breakdown of some common equity types and how they work:
As an IPO approaches, you’ll need to know exactly how many of each you have, what your exercise prices and vesting schedules are.
Different types of equity require different tax planning approaches, so there’s no one-size-fits-all strategy.
Here’s a scenario we see often: An employee has a large RSU vest tied to an IPO. The company may withhold federal taxes based on the standard supplemental wage rules. But because the payout is substantial, the employee may still owe additional taxes when filing.
This can create a significant withholding gap. Even though your employer withheld taxes, the amount may not fully cover your final tax bill, leaving you with a larger-than-expected payment due when you file.
If you don’t have the cash on hand to pay that tax bill, you may find yourself scrambling. This is where a tax expert can help you estimate your tax liability early so you can set aside enough cash to pay taxes when the time comes.
There’s an important thing to know about IPO day, and it’s a critical one — you cannot simply dump all your shares on the open market at that time. Most companies enforce a lock-up period, typically lasting around six months. During this time, insiders and employees cannot sell their stock.
The problem? Your tax bill on vested shares might come due before you can actually sell the shares to generate cash.
You need a clear selling strategy for the day your lock-up expires. Do not try to time the market. It’s much better to work out a schedule to sell portions of your equity over time, which limits your risk if the stock price drops and helps you transition your concentrated wealth into a diversified investment portfolio. You’ll need to consider and plan for the tax implications of any moves you make, of course.
Waiting until the IPO happens to make a plan is a guaranteed way to lose money. Instead, follow our checklist to help prepare for the big event.
Sudden wealth changes your entire life structure. The moment you hold significant assets, you expose yourself to new risks.
Most young executives have never had to think about trust and estate planning. If you have a spouse, children and newfound millions, a basic will no longer cut it. You need to plan for a living trust. If something happens to you without a trust in place, your estate goes into probate, which is sometimes jokingly called “probate hell” for a reason. The courts could freeze your assets, take a slice of your money and make your private financial details public — a process that can drag on and be difficult for your next of kin to go through. A living trust helps you avoid this painful process.
You also need to think about big purchases. For example, if you plan to buy a $5 million home with your new wealth, you need to consider property taxes, insurance and how tying up your cash in real estate impacts your ability to pay your income taxes. Instead, you should plan your cash flow before you start shopping.
People who suddenly strike it rich often make the same easily avoidable errors.
First, they assume their employer handles the taxes for them. Your company manages its own compliance, not yours. And, as mentioned earlier, the withholding they’ll do on your behalf may not fully cover your final tax bill.
Second, they fail to diversify. Keeping 90% of your net worth tied up in the company you work for is risky. If the company hits a rough patch, you could lose your job and your wealth on the exact same day.
Finally, they try to navigate the complexity alone. You know how to build software, lead a sales team or engineer hardware. Tax experts know how to navigate the IRS, structure trusts and protect wealth.
For many employees, an IPO is the biggest financial event they'll ever experience. The difference between keeping more of what you've earned and handing over more than necessary often comes down to planning before key decisions are made. Learn how our individual tax planning experts can help you understand your exposure, evaluate your options and move forward with confidence.
An IPO can create life-changing wealth almost overnight—but the decisions you make before and after it can determine how much you actually keep. See how our equity compensation and tax professionals can build a plan for your shares, your taxes and your financial future.
