How To Manage Stock Options When Your Company Has An IPO?

True Root Financial is a financial advisor and financial planner based in San Francisco, CA. We serve clients across the globe.

When your company announces an IPO, it’s an exciting and pivotal moment. While it signals growth and potential financial gain, it also brings mixed emotions, including anxiety about how the stock price will affect your holdings.

If you are a tech professional interested in learning how we can help claim your financial independence by investing wisely, minimizing taxes and maximizing your equity compensation, please book a no obligation call here.

Watch our video below for in-depth guidance on understanding and managing your stock options effectively with essential tips:

Key Takeaways

Understand the terms of your stock option agreement, including vesting schedules, exercise prices, and expiration dates
Be aware of the tax implications of exercising your options, and consult with a tax advisor to minimize your tax liability
Develop a financial plan for diversification, and long-term goals
Avoid holding too much company stock and ignoring tax consequences.

What is a Stock Option?

A stock option is a benefit that companies offer to employees, giving them the right to buy shares of the company’s stock at a predetermined price, known as the exercise or strike price. This price is typically set at the market value of the stock on the date the options are granted.

For example, if your strike price is $10 and you exercise when the stock is worth $50, the $40 difference (bargain element) is taxed differently for ISOs and NSOs. If you later sell at $50 per share, the $10 gain is a capital gain.

Types of Stock Options

There are two main types of stock options you might have:

1. Incentive Stock Options (ISOs):

ISOs are typically offered to employees of a company.
They come with favorable tax treatment if certain conditions are met, such as holding the stock for at least two years from the grant date and one year from the exercise date.
If these conditions are met, any gain from selling the stock is taxed at the lower long-term capital gains rate.

2. Non-Qualified Stock Options (NSOs):

NSOs can be offered to employees, directors, contractors, or others.
They don’t qualify for special tax treatments like ISOs.
When you exercise NSOs, the difference between the exercise price and the fair market value of the stock is taxed as ordinary income.

Understanding the type of stock options you hold is crucial, as it directly impacts your tax obligations and your strategy for exercising those options.

What to do post a company exit via an IPO?

Once your company has completed its IPO, it’s time to take a close look at your stock options and make a plan for how to manage them. Here are the key steps you should follow:

1. Review Your Stock Option Agreement

The first step in managing your stock options post-IPO is to thoroughly review your stock option agreement. This document outlines the terms and conditions of your stock options, including the number of options granted, the vesting schedule, the exercise price, and any expiration dates.

Key points to consider:

Vesting Schedule: Ensure you understand when your options become fully vested and eligible for exercise.
Exercise Price: Know the price at which you can purchase shares, and compare it to the current market price.
Expiration Dates: Be aware of when your options expire. Most stock options have a 10-year expiration from the grant date, but this can vary.

2. Understand the Tax Implications

Taxes play a significant role in managing stock options, and the type and timing of your actions are paramount in minimizing your tax liability. The tax implications differ based on whether you hold ISOs or NSOs.

Tax Treatment for ISOs:

If you exercise ISOs and hold the shares for at least one year before selling them and two years from the grant date, you’ll qualify for long-term capital gains tax on the profit.
However, the exercise of ISOs may trigger the Alternative Minimum Tax (AMT), depending on your income level and the spread between the exercise price and the market value of the stock.

Tax Treatment for NSOs:

When you exercise NSOs, the difference between the exercise price and the market price at the time of exercise is taxed as ordinary income.
This amount is also subject to payroll taxes, including Social Security and Medicare.

It’s critical to consult with a tax advisor to develop a tax strategy that aligns with your financial goals and minimizes your tax burden.

3. Exercising Your Stock Options

Exercising your stock options is a pivotal decision that requires careful consideration of timing, financial implications, and your overall financial plan.

a) When Can You Exercise?

After an IPO, there may be a blackout period during which employees cannot exercise their stock options or sell their shares. This period typically lasts for several months and is designed to stabilize the stock price after the IPO.
You’ll need to wait until this blackout period ends before you can exercise your options.

b) When Should You Exercise?

Deciding when to exercise your options depends on several factors, including your financial situation, the stock’s performance, and your long-term goals.
Some employees choose to exercise early to start the holding period for capital gains treatment, while others may wait for the stock price to rise.

c) How Many Stock Options Should You Exercise?

If you decide to exercise your options, consider exercising only as many as you can afford to pay taxes on. This approach allows you to take advantage of potential gains while managing your tax liability.
Some employees use a cashless exercise, where you exercise your options and immediately sell enough shares to cover the cost of exercise and taxes.

d) How Long Do You Have to Exercise Your Remaining Vested Options?

After leaving the company, you typically have a 90-day window to exercise any vested options before they expire. However, this period can vary, so it’s important to check your agreement.

The 90-Day Window for ISOs and NSOs

For ISOs, if you don’t exercise within 90 days of leaving the company, your options may convert to NSOs, losing the favorable tax treatment.
NSOs generally don’t have the same conversion risk, but the 90-day window to exercise still applies.

4. When to Sell Shares?

After exercising your options, it’s wise to consult with a financial and tax advisor to determine the most beneficial way to sell your stocks. The type of options you hold and the length of time you keep the stocks after exercising them will greatly affect your tax obligations.

5. Post-Exit Strategies

After the IPO and once you’ve exercised your stock options, it’s essential to have a solid financial plan in place to manage your newfound wealth. This is where a financial advisor can be invaluable.

Selling part of your stock and reinvesting in a diversified portfolio is a smart move that can help you move closer to early retirement. You might also use the proceeds to cover major expenses, like funding your children’s 529 plans or paying off student loans.

Common Pitfalls to Avoid

Managing stock options can be complex, and there are several common pitfalls to avoid:

1. Holding Too Much Company Stock:

While it might be tempting to hold onto all your company stock, it’s important to diversify your portfolio to reduce risk. Too much exposure to a single stock can be risky, especially if the stock price drops.

2. Ignoring Tax Consequences:

Failing to plan for taxes can lead to significant unexpected tax bills. Make sure you understand the tax implications of exercising and selling your options.

3. Failing to Plan Ahead:

Proactive planning is essential. Don’t wait until the last minute to exercise your options or make decisions about your stock. Have a strategy in place well before the IPO occurs.

True Root Financial Can Help You Develop an Exit Strategy for Your Employee Stock Options

At True Root Financial, we specialize in helping tech professionals manage their stock options and other forms of equity compensation. We understand the challenges and opportunities that come with an IPO, and we’re here to help you navigate them.

Whether you’re looking to minimize taxes, diversify your portfolio, or create a plan for financial independence, book a call below to meet our team of experienced advisors to help you develop a strategy tailored to your unique needs and goals.

How To Manage Stock Options When Your Company Has An IPO?

Key Takeaways

What is a Stock Option?