INSIDE THE IPOKnow What You Hold
Companies offer different kinds of equity compensation. It’s a benefit your company gives you as an incentive to help make the company succeed, thus increasing the price of shares for everyone. Your tactics for managing the proceeds will depend on which kind you have.
Stock options are one kind of equity compensation. The two types of stock options are incentive stock options (ISOs) and non-qualified stock options (NSOs). An ISO can only be granted to employees. The big advantage of ISOs is that, unless you are subject to the Alternative Minimum Tax (AMT), you don’t have to pay taxes when you exercise your options. You do, however, pay taxes when you sell the stock. NSOs, by contrast, are available to outside consultants and advisors, as well as employees. Holders of NSOs must pay taxes both when they exercise their options and when they sell their stock.
Firms sometimes offer employees another form of equity compensation: restricted stock units, or RSUs. RSUs are worth nothing until the settlement date, or the predetermined time when you are able to take ownership of the shares your company promised you.
In all cases, it’s important to try to get a fix on the value of your shares—something that can be a bit hard to do when your company is still private. One way of determining their worth is by looking at the most recent round of funding or by checking your firm’s 409A, a valuation which is an independent assessment of the shares’ fair market value.
Tax Questions
The tax implications if you decide to sell your stock are also a major consideration. If you have ISOs, for example, you get preferential tax treatment if you are able to meet the requirements of a qualifying disposition. To take advantage of a qualifying disposition, you must sell your shares at least one year after exercising the stock, and two years after the ISO was granted.
In such cases, when you sell the stock, you’ll have to pay capital gains tax on the difference between the amount you paid for the shares and what you sold them for, but the proceeds will be taxed as a long-term capital gain—and that’s an advantageous rate. By contrast, with NSOs, you pay taxes at the standard income tax rate on the spread between the price of the stocks when they were granted and the strike price—that is, the price at which the security can be bought or sold. And just as with ISOs, shares must vest before you can exercise your options.
Timing also comes into play when you sell your ISOs because under certain circumstances, you may be subject to the Alternative Minimum Tax (AMT). The AMT, which targets high earners, requires that you file an adjustment and pay taxes on the difference between the price you paid for the shares and their market value at exercise. A common strategy is to wait to exercise options and sell shares until after the IPO, then pay the AMT with the proceeds of the sale.
The SPAC and Direct Listing Factors
Aside from an often-lengthier lock-up period for the latter, there aren’t too many differences from an equity compensation perspective between IPOs and SPACs. SPACs typically try to maintain the same equity compensation benefits the original company has agreed to for their employees, although this is subject to negotiations. There is one possible bonus, though. Sometimes SPACs sweeten deals with cash.
As for direct listings, much depends on the arrangement you have with your employer. Anyone who owns company stock can sell their shares—and that’s good news. Once your firm has gone public, you can get your cash much faster out of vested but unexercised stock options, since there’s no lock-up period.
With direct listings, there’s a fair bit to process before the first day of trading. To avoid pitfalls such as making mistakes and to get your shares ready for sale, you’ll need all the guidance you can get from a financial professional.
A final thought: You have lots of options—literally. Make sure you prepare to take the best ones.
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