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July 21, 2021

IPO Lockup Period Expiration: What’s Next

Please read important disclosures HERE.

The company you work for has just had its initial public offering (IPO); it’s a very exciting time. All the hard work and belief you put into the company over the years is set to be rewarded. Now all that’s left is to wait for the six-month lockup period to expire before you’re free to sell your shares and realize the payoff from your efforts. During the six-month lockup period you’re likely to experience a range of emotions from thrilled to anxious, especially because the public market stock price can be checked multiple times a day. However, you won’t be able to do anything about the fluctuating price.

Going Public Stock Market Initial Offering IPO Surrounded by Stocker Ticker

The lockup period is a good time to take an inventory of your equity awards. You may have some combination of stock options (both incentive stock options and nonqualified stock options) as well as restricted stock units that have vested at various times. It’s helpful to work with your financial advisor and tax preparer to determine a game plan and tax strategy for the optimal order in which the awards should be sold.

Most people have a plan in mind for selling (or not selling) their shares once their lockup period expires. There are typically big financial and life goals to consider such as buying a house, transitioning into a different type of work, or maybe even starting an early retirement. All that thoughtful planning, however, can get thrown out the window once the day to sell actually arrives. You may feel the stock price is too low to sell now, or it may be rising too rapidly to sell now, or the market may be experiencing a correction that’s unfairly bringing down the company stock even though the company itself is doing great.

There is no one-size-fits-all recommendation for managing concentrated employee stock positions simply because every situation is different. Also, the decision to sell stock doesn’t need to be an all-or-nothing choice. In many cases, the optimal road is the middle road, where a significant portion of stock can be sold while also holding onto the remaining portion in hopes of future appreciation. This may be a rare instance when you can have your cake and eat it too. One key theme that cuts across any choice you make is that the focus on risk should be at the forefront of the decision, a step ahead even of the potential investment returns. 

Many financial advisors will recommend selling a large amount of your company stock as soon as you are able to, especially if it represents a significant portion of your wealth. This advice comes from one of the fundamental tenets of modern portfolio theory, which is that investors are not compensated for idiosyncratic risk in investing. Put another way, the potential rewards of holding a single stock do not justify the outsized risk of holding that stock when compared with the risk/reward tradeoffs of a diversified basket of investments. 

Advisors give this advice hoping that it’s wrong. We hope that the employee’s company stock thrives and over time significantly outperforms the market. We’ve certainly all seen examples of this from Facebook, Google, Amazon — the list goes on and on. However, there is also a very real risk that any company will underperform the market instead, or even worse, be unsuccessful in its future endeavors, wiping out a great deal of its market value. This notion can be counterintuitive, as putting all the eggs in your company basket is what got you to this point in the first place. So why wouldn’t you continue along the same path? Though the potential upside of a single stock is enticing, advisors understand that the downside risk of the single stock concentration is too much for most clients to bear. 

With that said, it’s important to bring these concepts back to the individual and their specific goals and financial plan. By choosing to reduce a concentrated stock position, an investor can significantly narrow the range of potential outcomes in their financial plan. For example, a $5 million position in a newly IPO’d company can easily double to $10 million in a short period of time and grow even more from there. This knife cuts both ways though, and the stock can also potentially be worth $1 million or less in an equally short period of time and may never recover its IPO value. The upside of taking a $5 million portfolio to $10 million is exhilarating, but the downside of taking a $5 million portfolio to $1 million is magnitudes more excruciating and would derail any good financial plan. 

Unfortunately, the list of IPO horror stories is also long: Lending Club, Wish, Groupon, and so on. And it’s impossible for anyone to know today whether you’re holding a winning or losing ticket for the long term. Eliminating the risk of a single stock wiping out most of one’s wealth is a top priority that drives the decision to diversify. By selling a large portion of the shares (and paying the taxes) you can substantially narrow the range of potential outcomes for your financial plan and may help protect it against the worse-case outcomes. Though it will potentially take longer to double your portfolio, in return you’ve potentially eliminated the chances of the portfolio declining materially from owning a large, concentrated stock position and not subsequently recovering value over time.

A good financial plan can help you to understand the value of a diversified portfolio. Let’s say you have a diversified portfolio worth about $2.5 million (a $5 million stock position net of the 50% tax rate from selling shares). A $2.5 million diversified portfolio that earns an annual rate of return of 6.5% over the subsequent 20 years is projected to grow to $8.8 million if we assume no contributions or withdrawals. This figure is enough to fund a very healthy and active retirement even in an expensive location like the Bay Area while also providing a significant legacy for heirs. This scenario provides a great deal of financial security and it allows for the option to spend time working in areas that may not pay as well but are interesting and fulfilling in other ways. At this point, you would have a very successful financial plan even if you never saved another dollar in your lifetime. On the flip side, you may be giving up the potential for a huge windfall if your concentrated company stock position were to hit the moon. But the “less risky” option helps you also minimize the worst-case scenario — which is ultimately the most important piece of the puzzle. 

We encourage clients to keep focused on their long-term plan. We find that it’s valuable to shift the focus from the future stock price of a single company to one’s overall financial goals and the key risks that could derail those future plans.

If you would like to talk more about strategies for diversification after an IPO, please connect with a member of the B|O|S wealth management team.

Filed under: Wealth Management

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