Managing Lock-Up Periods During Volatile Markets

The recent volatile stock market is trouble enough for any investor, but for employees holding stock shares during a post-IPO lock-out period, it can make the difference between boom or bust.

Early employees in a firm, typically executives and other department heads, are often awarded stock options as part of their compensation. The goal is a big pay-off when the company is successful and seeks to raise more capital in the public markets.

But when a company launches an initial public offering (IPO), there is usually a six-month lock-up period when employees can’t sell their shares. After the firm goes public, black-out periods prevent you from buying and selling shares in the weeks surrounding quarterly earnings reporting. Both of these closed periods can cause some wealth management challenges as you really have no idea what the price will be once you’re permitted to sell.

Your instinct may tell you to wait to see if the stock shares grow, but history often shows the price may decline over time and never actually recover. By the end of 2021, two-thirds of companies that went public that year were trading below their IPO prices, according to The Wall Street Journal. This year and the near future will likely be tougher as a potential recession looms.

Firm leaders are usually optimistic about the future of the companies where they work. While it’s normal to dream big when you see that initial IPO price, it’s best to take a thoughtful, measured approach to managing this ephemeral equity. Even if you do realize great gains, taxes can take a big bite out of the income if you don’t plan carefully.

If you’re at a firm that is planning a liquidity event, here are a few key considerations and planning tips to manage stock during lock-out periods:

Articulate your life and financial goals

Before you do anything with these shares, you need to think about what you want from life. Everything ─ where you want to live, caring for a partner and family, recreational and hobby pursuits, your entrepreneurial vision for the future, retirement, philanthropy, inheritance to younger generations and other financial responsibilities ─ should be carefully considered and discussed with the important people in your life. Think about how long you want to stay at this company, as well.

These goals should form the foundation of your wealth management plan. Once you have a map of where you want to go, then you can figure out how to get there, with proper budgeting and expense management for your current income. Of course, things can change along the way, and a solid financial plan will be flexible to adjust with those changes.

Understand the stock and options you’ve been granted

There are different types of equity, each with their own limitations and tax considerations. Common forms of stock compensation include:

• Incentive stock options (ISO) — When you exercise ISOs, the difference between the strike price and the market value is only subject to Alternative Minimum Tax. When the shares are sold, you have different basis for regular and Alternative Minimum Tax calculations.
• Nonqualified stock options (NQSO) — When you exercise NQSOs, you pay ordinary income tax on the difference between the value on the day you exercise and your strike price. When you sell those shares, you pay short or long-term gain taxes on the difference between the market price and the full market value at exercise. If you exercise and sell the share the same day, all your income will be ordinary income.
• Restricted stock units (RSU) — RSUs are put on a vesting schedule and commonly vest only upon satisfaction of both a service condition and performance condition. The value of the shares upon vesting are taxed as wage income.

Determine how much of your investment portfolio they comprise

It’s not unusual for an executive’s company shares to represent the largest portion of their overall investments. When prices are good, you may feel you can live large. But if the company declines, so do your fortunes. This is known as a concentrated wealth risk, and you should plan on how to gradually dispose those shares and diversify your portfolio with other investments to minimize that risk.

File 10b5-1 plans

Before selling any shares, certain executives will be required to file 10b5-1 plans with the Securities and Exchange Commission. Depending on your role, you should voluntarily file them as well. These plans will establish a certain date or price for selling a specific amount of stock. It may limit your potential upside, but it’s for your own protection against accusations of insider trading.

Figure out the tax implications

The income you receive from selling shares should be computed with your salary and other income. Proper planning may reduce the percentage you send to Uncle Sam. For example, if you set up a charitable donor advised fund prior to the liquidity event, you could transfer shares to it. Not only will you not realize the income tax on the gains, but you can also write off the donation. And your favorite charities can benefit from your success.

Don’t forget to also consider the timing of when you must pay the federal and state government. A large liquidity event may require you to begin making estimated tax payments to reduce or eliminate the exposure to underpayment penalties.

Hire financial help early

With so many details to consider and numbers to compute, it’s important to hire an independent wealth manager who can analyze your total assets, help you develop a wealth management plan, guide you on a disposition plan, and recommend a diversified portfolio that will help you to achieve your financial goals.

You should do this before the liquidity event. It breaks my heart when we start working with new clients who could have held onto more of their hard-earned gains or made a greater impact with their wealth if they had only talked to us sooner. It’s best to seek out financial help when you’re first given equity compensation. Then you can worry less about market volatility during restrictive lock-out periods and instead focus on making the company a success and living the comfortable life you’ve envisioned.

(Chris Murray, practice leader in tax services and Aspiriant partner, contributed to this post.)