Spotify and Dropbox are two big tech players (which we use. A lot!) that are going public at multi-billion dollar valuations. Great news, right?
It may be safe to assume that going public is a good outcome for most startup founders and investors, but what does it mean for their employees? What happens to their stock options or shares when the company goes public? Can you get $5.2 billion richer like Facebook employees did? This post will discuss just that.
A Quick Refresher
Before we go there, a quick refresher on stock options. Startups use stock options as a form of compensation that gives their employees the right to participate in the company’s success. Receiving options gives employees the opportunity to buy the company’s shares at a predetermined fixed price. If the share price increases over time, employees can basically purchase shares at a discount since the predetermined price (exercise price) they pay is set at the outset and it does not change over time.
In other words, as an employee, your potential profit comes from the increase in the company’s share price, or the company’s value appreciation. The nice thing about this, is that you, as an early employee, can really contribute to the company’s growth and make an impact when it comes to its value and share price. There are plenty of things we can’t control or even impact in our lives, so it’s nice to be able to have some influence here.
If you want to learn more about option basics before continuing to read this post, check out our earlier post here.
Now, to our topic.
As mentioned in our Beginner’s Guide to Stock Options, there are two things that must happen for you to turn from an option holder to a true shareholder – the options must vest, and you must exercise them. We will discuss the different outcomes and treatments of your options and shares on IPO using these parameters.
Vested Options That Have Been Exercised, aka Shares
If you own shares of the company, an Initial Public Offering (IPO) is probably the optimal exit scenario you can hope for as an employee. There are two reasons for that. The first reason is that IPOs are typically done from a position of strength and with favorable terms, when compared to the company being acquired by another company (not always, but in most cases). That means that an IPO could result in a profit to many of the company’s employees. Earlier employees will typically earn more than later ones, but in general, employees should enjoy some piece of the pie in this scenario.
The second reason is that an IPO gives employees control on when to liquidate their shares and turn them into cash. With the exception of a lockup period, which is a period of 90-180 in which insiders (including employees) are not allowed to sell their shares, you can decide what timing works for you. If you think the company’s shares will continue to go up in value, you can continue to hold them. If you want out, you call sell them all on day 181. If you’re unsure but want to limit your risk, you can just sell a portion. Since the shares are now listed on a public exchange, you’re in the driver’s seat when it comes to timing.
Vested Options That Have Not Been Exercised
You get to keep those as if nothing happened. The only thing that changes is that you now have an actual share value to compare your strike price to, and that share value is not hypothetical since you can sell them right away. If your strike price is lower than the price the company’s currently trading at, you can exercise your options and either hold them or sell them immediately (assuming the lockup period is over).
If you have options that have vested but have yet to be exercised, the company may give you the opportunity to exercise them before it goes public. This may be beneficial from a tax standpoint since you may be able to save some money if you believe that the company’s value post IPO will be higher than its value just before the filing. This will also depend on the type of options you have and your personal tax situation, but it’s worth considering since it can put some more money in your pockets.
The faith of the unvested will be determined by the company’s stock options plan. In most cases though, nothing changes and your options will continue to vest as long as you stay with the company. Once they vest, you can compare their strike price to the then-current market price and decide if it makes sense to exercise them.
One thing that’s worth checking before the company goes public is if it offers an early-exercise option. Early exercise allows you to exercise your options before they vest to save on future taxes. If you leave the company, then you’ll get money back for the portion that has yet to vest. If it looks like the company is going to increase in value post IPO, you may want to take advantage of such opportunity prior to the filing.
Planning is Key
Filing for an IPO takes a lot of planning on the company’s side. It’s a huge step in the company’s life that has a major financial impact. Similarly, employees should properly prepare for this day and make sure they make the most of the options and shares they’ve earned over their time with the company. Planning ahead and making the right decisions at the right time can make a big difference on how much money ends up in your pocket.
Although an IPO can many times deliver the optimal result for employees, it’s not the most frequent exit scenario. Most exits occur when a company is acquired by another company using cash, stock or a mix of both. We will cover these scenarios in later posts.