Tips for personal financial planning before an IPO

Ann Lucchesi

Key takeaways

  • Setting goals and identifying priorities with your advisors will help you gauge your tolerance for risk, cost and complexity.
  • If you are a founder, an angel investor or an employee of a successful early-stage company, part or all of your shares may be eligible for qualified small business stock (QSBS) exemptions.
  • If you don’t have an estate plan already, this is a critical time to create a basic plan that includes a will, living trust, health care directive and financial power of attorney.

You can never begin too early to plan for a liquidity event, but if you are like most founders, you likely have not taken time to plan for the impact on your personal finances. As a rule of thumb, if you are within 12 months of a possible IPO, you should take steps towards attaining the best outcome for building your personal wealth.

Even before you start interviewing underwriters, identify a financial advisor experienced in planning around IPOs/M&As and consult tax and estate-planning professionals. The goal is to get experts to help you prepare a strategy well in advance.

Here are key steps and questions to help you plan:

What are your goals?

To make decisions around exercising options or transferring wealth (either via irrevocable trusts or philanthropic planning), you need to understand the risks and tradeoffs. While tax minimization may be part of this plan, you should remember that exercising options early or transferring wealth has major tax implications. Setting goals and identifying priorities with your advisors will help guide your decision-making.

What tax exemptions are most relevant?

If you are a founder, an angel investor or an employee of a successful early-stage company, part or all of your shares may be eligible for qualified small business stock (QSBS) exemptions, which may protect up to $10 million (or 10 times your cost basis, whichever is greater) from federal taxes. To determine this, you need proper documentation. Ask your company auditor or accountant to prepare a memo identifying which shares on the cap table may qualify. Understanding these tax implications is critical before you make decisions on how and when to trade, transfer or gift these shares. For a deeper explanation of QSBS, please read Startup Taxes: Making the QSBS Exemption Work for You.

Is it better to exercise or hold stock options?

Let’s discuss key decisions around exercising options. Deciding when to exercise incentive stock options (ISOs) is critical and should be reviewed near the end of each year. The ability to exercise ISOs without paying alternative minimum tax (AMT) is a great incentive, and the benefits may change from year to year, depending on your personal tax situation. The 2017 tax law reform changed AMT slightly, and it may be more advantageous to exercise ISOs this year than in previous years. Ask your tax advisor to model the cost of exercising vs. the expected gain. A key milestone to consider is when your company moves from getting annual to quarterly 409(a) valuations. Often this is the point when the price spread between common and preferred shares narrows rapidly. It is also very important to recognize that exercising options often means taking on additional risk and should not be viewed only as an opportunity to minimize taxes. For example, you may choose to hold your options risk-free until the expiration date, and if you go public, then sell the shares simultaneously with the exercise to mitigate risk. Of course, this likely will result in paying a higher tax rate on the gains.

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How will liquidity activity affect estate planning?

If you don’t have an estate plan already, this is a critical time to create a basic plan that includes a will, living trust, health care directive and financial power of attorney. You’ll need these pieces in place before you begin any advanced estate planning. You should carefully consider your goals before deciding which type of trust structure to put in place. Much like stock option exercises, this may be one of the best times to take advantage of wealth transfer strategies. With the 2017 tax law, lifetime gifting and estate tax exemptions increased to $11.7 million for an individual and $23.4 million for a married couple for 2021. These higher exemption levels carry sunsets at the end of 2025, so plan ahead.

How do I time liquidity?

Some companies allow founders to participate in selling shares on the day of the IPO, but more likely you will not be able to sell shares until the end of the underwriters’ lockup period that typically restricts sales until six months after the IPO. If you are still with the company six months later, you are also likely subject to internal trading windows that may not be open at the end of the lockup period, thereby lengthening the time before you can get some liquidity. But there are tools to tap liquidity in advance, including a bridge loan or restricted stock loan just prior to the IPO (Silicon Valley Bank offers this type of loan in certain circumstances). While you may be able to pledge shares to obtain a loan before an IPO, this may not be the case post-IPO if you are an employee. That’s why understanding your liquidity and cash flow needs ahead of time is so important.

Often, we find that executives and founders are very enamored of the idea that their company’s stock will only go up, and they ignore the potential downside risk. Too many things are outside the control of a company, such as recessions, black swan events and changing business environments and have wiped out fortunes in past market cycles. Its important individuals devise a diversification strategy to reduce concentrated positions and stick to their liquidity plan.

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How can I gain more flexibility?

First, you need a clear understanding of your limitations on selling shares post-IPO. Will you be a Section 16 officer or an insider? Either way, you will likely want to use a 10b5-1 trading plan. This type of plan typically requires liquidation planning a year out or longer, but it allows you to sell shares in the future regardless of trading windows. Companies going public generally put tight restrictions around your ability to implement such plans. It is recommended that you begin thinking about the plan post-IPO but before any lockup ends. At this point you may have more visibility into where the stock is trading. Before going ahead, you will want to work with your advisory team to craft a strategy that considers your financial goals, tax implications, grants expiring within two years and future grants.

When do I devise an investment strategy?

Before you trade shares, you will want an investment strategy in place. As discussed above, portfolio diversification is highly advised. The best plan establishes desired liquidity levels first, then sets the investment decisions. That’s why it is important to think hard about your long-term goals so that you may properly fund an investment strategy. The more disciplined you are in applying the strategy, the more likely you are to reach those goals.

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If you are inclined, this may also be a good time to consider a charitable-giving plan. Accounts such as donor advised funds and charitable giving funds allow you to make contributions in high-tax years but then spread out the gifts over a period of time. By gifting stock, you can often avoid paying taxes on large gains and keep those dollars in the fund. If you are considering significant wealth transfer through philanthropy, you may want to consider a private foundation. Again, these are complex decisions with significant implications for tax planning and your personal finances.

On a final note, when planning for an IPO, it is important to properly assess risk and reward for your own personal finances. People often focus solely on tax minimization and don’t understand that they may be taking on excess risk in the meantime. And sometimes, irrational exuberance takes hold causing individuals to want to hold on to their stock, but stick to the plan. Be sure to tap experts who can help you identify your goals and gauge your tolerance for risk, cost and complexity. Your Private Bank Relationship Manager can help guide you and connect you to the correct professional advisors.

Download our infographic that outlines the financial planning steps to take before an IPO.

Ann Lucchesi

Ann Lucchesi is an enterprise relationship manager at Silicon Valley Bank in San Francisco. She works within the commercial banking division, serving as a key contact between tech banking and the private bank, delivering educational programs and providing thought leadership.

The views expressed in the article are those of the author and/or person interviewed and do not necessarily reflect the views of Silicon Valley Bank, a division of First-Citizens Bank and First Citizens BancShares, Inc. The materials on this website are for informational purposes only, are subject to change and do not take into account your particular investment objective, financial situation or need. Since each client’s situation is unique, you should consult your financial advisor and/or tax planning professional before acting on any information provided herein.