WEALTH INSIGHTS

Three things to know pre and post IPO

Shannon Saccocia, Chief Investment Officer, SVB Private, and Dave Buxton, Relationship Manager, SVB Private, discuss important factors.

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Transcript

Shannon Saccocia: Hello and welcome to the Perspectives podcast, I'm Shannon Saccocia, Chief Investment Officer at SVB Private bank and I want to thank you for joining me today. On today's podcast, we'll discuss three things to know on your journey to IPO. Joining me on the podcast is Dave Buxton, Relationship Manager at SVB Private Bank.

Dave, why don't you tell us a little bit about your role here at the Private Bank?

Dave Buxton: Sure, thanks Shannon! It's good to be with you today. I'm the market manager on the East Coast here for Silicon Valley Bank. I've been with the bank for eight years. I'm a certified financial planner and a certified wealth strategist, and my role basically focuses on helping founders and executives of tech and life science companies manage both sides of the balance sheet and also prepare for liquidity events.

Shannon Saccocia: Great, well that all seems very timely as we think about our conversation for today. So first off, I'm going to take a few moments and just set the stage and talk a little bit about what's been happening in the markets. So, if we look at what's happened so far in 2022, it's not unexpected given that we expected the Fed to go into this more tightened monetary policy stance, and that means that we're expecting them to taper their current bond purchases and raise interest rates.

All of this has been very well telegraphed by the Fed over the course of the last few months. And a lot of the weakness that we've seen in the technology sector actually started back in October and November of last year in anticipation of this tighter policy. If we look at what happened in January though, it really accelerated in terms of what the market was expecting versus what the Fed was delivering, and so the Fed started to deliver perhaps a more hawkish message around the pace of the taper, the pace of tightening, and perhaps most importantly, an actual change in the way that they think about their balance sheet. So, if we go from a period where we've had massive quantitative easing, meaning the Fed allowed their balance sheet to continue to grow, to now quantitative tightening where they're actually looking to contract the size of that balance sheet.

That's certainly a change that many investors were not anticipating here in 2022, and something that we really were looking at for 2023 and beyond. So how do we think about marrying what's happening with the Fed to what's happening in the equity market? Clearly, growth stocks you know not just technology but other adjacent industries, communication services, parts of the industrial sector, parts of the healthcare sector have all benefited over the course of the last decade through a low-rate environment.

It's not just for borrowing though, and that's an important point. It's not just because these companies could borrow at very low rates. In fact, it has a lot more to do with the fundamentals around their stock price. When you have cash flows the way that fundamental analysts look at stock prices is that they discount those cash flows in the future by a certain discount rate. Generally, somewhere around the Fed funds rate or the two-year treasury rate, some variation of rates that are being set in the marketplace.

So, if you think about it, a lot of growth companies have a lot of their expected cash flows in the future, and if you're trying to determine value on a stock price, you’re discounting those cash flows at a higher rate for the next several years. It's almost like an automatic depreciation in the multiple overnight when you start to see these interest rates increase. That sets a more challenging backdrop for companies that are looking to enter the market this year. So, over the last couple of years, we've seen meaningful IPO activity, meaningful stack activity and there was a lot of investor appetite because frankly these stocks had done really well over the last decade, really since the great financial crisis. And so these long duration stocks are underperforming in the market now. They are potentially set to underperform over the next year or so as we see this interest rate cycle really kick off. And investor appetite seems fairly low for the types of companies that would come to market over the last few years.

And so, as we look out over the next 12 to 18 months, our viewpoint is that it could be a more challenging environment for founders and investors to be able to monetize those investments. And so, I thought it made sense for us to bring in Dave and talk a little bit about our unique viewpoint given our proximity to these companies. Dave, what have you been seeing in your conversations?

Dave Buxton: Well, you know Shannon, 2021 was a record year for IPOs. Stack activity has since slowed dramatically and the stock price performance has been poor, but we don't feel like the windows closed. And you know, having said that, the way we look at it for founders and execs of the companies that we bank, it's really never too early to start planning.

We recommend that folks start to assemble a team comprised of a CPA and a state planner and a wealth advisor approximately 12 months before they think their company may go out. And you know the first step there is once you have the team assembled, is to define your goals: things like tax minimization, wealth transfer, etc. Each goal has pros and cons, but it's important to outline them first, so as you go through the decision-making process, you really use them as kind of your guiding principles or your North Star if you will.

You know an example of that would be when to exercise stock options, whether they're incentive stock options or non-quals. You know there's a lot to think about there, and for incentive stock options, for example, you can exercise a certain amount every year and avoid paying AMT tax. It's a great incentive, but that changes from year to year. That's why it's so important to have a CPA that you can rely on to help you calculate what the potential tax hit could be so that you really know what you're getting into before you actually make that exercise.

Shannon Saccocia: So, Dave, can I drill into that just to be clear, because I think one of the things that we see in our conversations with our clients is that they're coming to us with a transaction that is happening fairly quickly thereafter or has already occurred and they're looking for that advice. When is it too early to engage in these conversations with these partners?

Dave Buxton: So, you know, it's hard to say exactly when to engage, but maybe I could illustrate it with an example around exercising options. So, you know a lot of folks say hey, I want to start I want to exercise my options to start the long-term capital gains clock ticking. But when you do that, you take on additional risk. So, you really want to understand what type of options you have and how they're taxed.

You know, sometimes folks as an alternative will wait and they wait for the company to go out, wait for the lock up period to be over and they'll sell, exercise and sell simultaneously. Now what that does is that lowers the risk, but you pay higher taxes. So, you know, it really is a trade-off of the two. You know another thing to think about when you have existing shares, so not options, but actual shares in the company is understanding if they're qualified small business stock exemption eligible. And again, that's something that you can work closely with the CPA on because the tax advantages there can really be meaningful. But a lot of times folks will approach us then either have not filed the correct election, which is called an 83 (b) election, or they simply don't even know about this special exemption, which oftentimes can you know lead to up to a $10 million tax free ownership once you exercise the stock so it can be really meaningful.

Shannon Saccocia: Well, I notice you mentioned QSBS and we've started to see several articles on that out in the financial press, so that's certainly something we're going to continue to think about and monitor for our clients. From an estate planning perspective, what is sort of the basics that, you know, well before a transaction such as this is to occur that that our clients should be looking to have in place?

Dave Buxton: Sure, so we always recommend that you have the basic estate plan in place and that would consist of a will, a living trust, a health care proxy, and a financial power of attorney. And once you have those in place you can start to think about more advanced planning structures. Uh, this goes back to the wealth transfer strategies that I mentioned earlier. Currently, the lifetime gift exemption is approximately 12 million per individual and 24 million per couple, however, those are going to sunset in 2025. So, you know, assuming your company is going to go out in the next, you know 1-2 years, this is something you really want to look at now because once those sunset, the lifetime gift exemption will be most likely to reduce dramatically.

Shannon Saccocia: So, with that said, I'm sure some of our listeners are saying well, but Shannon just said that we might not see the same level of IPO and SPAC activity and so this horizon, which for many private stockholders has been longer than they anticipated, you know, over the last five to 10 years, that continues to be lengthened. Is there any way that SVB Private Bank can help if those expected liquidity events are going to take place a little bit later than anticipated based on this change in market sentiment?

Dave Buxton: There's a few different ways we can help, and I think just to you know, kind of tag on to your point there, lot of times these founders that are very excited to sell shares once the company goes public, but there's also often a six-month lockup period, so you are really extending that horizon. We do have the ability in some instances to offer private stock loans to our clients and then also once companies do go public, but the shares are not actually ultimately sold yet because of the lock up period, we can do a restricted stock loan. There are many factors that we need to align, but it's definitely possible.

Uhm, you know the other thing we find is that sometimes that founders and execs are you know reluctant to sell shares once they do come off lock-up because they have a high conviction in their company. In some ways, this was their baby that they've grown, and now they've seen this great event like I said, going public, wealth creation, etc. and it's very emotional. However, we have seen time and time again companies will go out, it'll spike an IPO and then, you know, not all companies, but sometimes you know the companies just don't perform well or maybe the, you know, market sentiment or there's different market factors that will really impact the price. And unfortunately, I've seen a lot of wealth evaporate because folks were so convicted in their company.

So really, one of the things we do strongly recommend once the shares are off lock-up and are able to be sold, we recommend that we look at a diversification strategy, and it's okay to keep a large portion of one’s shares. But really, the best thing to do for clients and their families is to help them work through and develop a diversification strategy so that they're avoiding the concentration risk of having all of their, you know, eggs in one proverbial basket if you will.

Shannon Saccocia: Yeah, and I think it's an important thing to note in terms of, you know, diversification doesn't, to your point, necessarily mean just selling, right? It can be a combination of gifting. It can be you know long term time horizon planning in terms of when they might need liquidity for different life events, so it's much more nuanced than you know, taking a 50% cut in the position and then just diversifying that geographically and across other markets. You know, I think one of the things that I'd love for you to point out is, you know when you're working with these types of clients, you know with SVB’s focus on the innovation economy, you know how much value are you able to add as part of the relationship given that you've worked through so many of these different scenarios for clients in the past?

Dave Buxton: That's a great point, Shannon. Really, all we do is we focus on working with founders and executives in the innovation economy. So, we've developed a deep understanding. Oftentimes, you know, advisors if you will, they work with several different facets and different folks from you know different walks of life. We're really laser focused at SVB, focusing on innovation economy, and so we've done this so many times with so many different families that we've developed a deep understanding of any pitfalls or blind spots that our clients may have. And really, I think what we can do is bring our clients up the learning curve very quickly and let them know what's most important and what they need to be addressed now and what things can wait.

Shannon Saccocia: Thank you so much Dave! Our clients are lucky to have you and your expertise on their side and we're certainly happy to have you on our team as well.

Dave Buxton: Thank you.

Shannon Saccocia: Dave, there were a few terms that you brought up in this discussion that I think would be helpful to provide a little bit more detail, could you go into that?

Dave Buxton: Sure, Shannon. I think I mentioned AMT, which is the alternative minimum tax. It's basically government sets a floor on the percentage of taxes that a file or must pay every year.

Shannon Saccocia: And I think you talked about ISO's as well. Do you want to just explain those for the audience for those who may not be as familiar with that term?

Dave Buxton: Sure. ISO's are incentive stock options which are granted by the company to employees.

Shannon Saccocia: Great, thanks so much Dave! Thanks again for listening in! We'll keep digging into topics that impact your financial future, so tweet me at Shannon Saccocia if there's something you'd like us to cover in a future podcast.

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