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Considering an IPO? Don’t Neglect Personal Financial Planning

November 11, 2021

Are you thinking about going public? Before you decide on an initial public offering (IPO), think about how factors including timing, liquidity and qualified small business stock will impact your business.

To make the most of an initial public offering (IPO), you need to plan for how it will affect your personal finances. Don’t wait until you’ve made the decision to go public to form a strategy. Start thinking now about the following issues that could make a significant difference in your financial outcome.

Exercising Stock Options

It is important to be organized and keep a summary of your stock holdings and stock options. This will help you and your advisors determine the best approach. If you have unvested shares, an IPO won't typically change the vesting schedule and could result in accelerated vesting. You'll need to determine when to exercise any vested options. Review the internal company valuations (409A) as compared to your strike price on the options. Any spread between the two amounts could lead to significant ordinary income upon exercise. If the IPO doesn't happen, you could be left with a big tax bill with no proceeds to pay it. Timing is also important. Holding the stock for more than one year will result in long-term capital gain treatment and a lower tax rate.

Election Sec. 83(b) Treatment for Gains

The vesting of restricted stock units is a taxable event, and you’re generally taxed at ordinary income rates based on the fair market value (FMV) of the shares at the time of vesting. If you make an Internal Revenue Code Section 83(b) election, however, you’ll be taxed on the FMV of the shares on the grant date.

Sec. 83(b) elections are available only for stock that’s subject to vesting. As such, they’re also applicable — and generally advisable — if you early exercise incentive stock options and nonqualified stock options. If the value of the stock increases over time, making this election will reduce your taxes.

Keep in mind that exercising incentive stock options can lead to alternative minimum tax (AMT) liability. The tax law changes from TCJA in 2017 made AMT less of an issue but you could still find yourself paying a little extra in tax. Timing will play a large role in this determination. AMT liability isn’t always a bad thing, but you’ll want to take the possibility into account in your planning.

Timing Your Liquidity

Odds are, you won’t be allowed to sell your shares on the day of the IPO. You usually must wait until the underwriters’ lockup period expires, generally six months after the IPO. And, if you’re still employed by the company at that point, you may be subject to company-imposed trading windows. But you might be able to circumvent these restrictions by, for example, obtaining a bridge loan or restricted stock loan before the IPO.

Founders sometimes fall into the trap of thinking the stock price will continue on an upward trajectory, causing them to hold their shares for too long. It’s wise to diversify your portfolio so it won’t be devastated in the case of unexpected circumstances, such as a recession or dramatic change in economic or industry conditions. This is especially true if you’re employed by the company and stand to lose both your job and your portfolio if the worst happens.

Claiming the QSBS Exclusion

Under Internal Revenue Code Sec. 1202, capital gains from qualified small business stock (QSBS) are excludable from gross income. You may be able to exclude up to $10 million of capital gains or 10 times your cost basis, whichever is higher. That means you avoid the 20% long-term capital gains tax, plus the 3.8% net investment income tax. Stock acquired after September 28, 2010, is eligible for 100% gain exclusion. The exclusion also creates potential estate, gift and state tax saving opportunities.

Estate Planning

Spending the time to review your estate plan ahead of the IPO could yield significant income and estate tax savings. The IPO could come with potentially life changing liquidity. Work with a CPA and an estate planning attorney to get your fundamental estate plan in place. Take advantage of basic wealth transfer strategies to use some of your lifetime exemption and potentially multiply your QSBS exclusion.

Get Started Now

Going public is an exciting time in the life cycle of a business. But overlooking personal financial planning issues associated with an IPO can prove costly. Our PCS Group can help you cover the bases before it’s too late.

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