What happens to employee stock options when a company IPOs?
When a company conducts an initial public offering (IPO), it signals a pivotal moment for its future and the future of its employees. For employees with stock options, IPOs can be both complicated and exhilarating. Just what are employee stock options, though?
Simply stated, they are a type of equity compensation that gives an employee an opportunity to purchase company shares at a predetermined price, known as the “exercise” or “strike” price. If the company’s share value surpasses the exercise price, employees can take advantage of purchasing the stock at a relative discount and possibly profit from the difference.
But what happens to these stock options when a company goes public? The following overview explores the factors employees should consider when their company goes from a private to a public entity.
What changes with employee stock options during an IPO?
When a company conducts an IPO, employees with stock options often contemplate how this will affect their holdings. IPOs typically cause changes in the stock options’ value, vesting and exercise methodology. Here are a few key aspects to understand:
1. The value of stock options post-IPO
Private company shares are not as liquid as public shares, which is why an increasing number of private company shareholders seek to unlock equity in their private company shares with Forge. When a company IPOs, their stock becomes publicly tradeable and there are greater liquidity opportunities. This means employees who exercise their stock options can sell the resulting shares on the public market after an IPO, attaining gains if their strike price was below the company’s current share price.
2. Vesting and exercise of stock options post-IPO
Even after a company goes public, employees still must satisfy their stock options’ vesting requirements. If an employee’s options haven’t yet vested at the time of the IPO, they may forfeit the unvested segment. But after options vest, employees may exercise them, meaning they can obtain the company’s stock at the strike price, even if the share price climbs significantly post-IPO.
3. Tax considerations
The tax implications of post-IPO stock options can be substantial. When employees exercise their stock options, they will likely owe ordinary income tax on any difference between the strike price and the value of the stock at the time of exercise. Further, if employees retain the shares for more than one year following the IPO, they might be eligible for favorable long-term capital gains tax rates at the time they sell the stock.
Employee shares and the IPO lockup period
Employees should be mindful of the ‘IPO lockup period.’ After a company goes public, there’s usually a lockup period ranging from 90 to 180 days—during which time employees are prohibited from selling their shares. This lockup period aims to prevent the market from being deluged with an overabundance of shares after the IPO, which could adversely affect the share price.
During the lockup period, those who exercised their stock options pre-IPO may be unable to sell their shares. But this period also presents an opportunity to evaluate the stock’s performance and make a strategic decision about whether/when to sell after the lockup period expires.
Stock options post-IPO: A strategic decision
For employees with stock options in a company on the verge of going public, it’s wise to develop a thoughtful strategy. While an IPO is exciting, it’s critical to consider the risks and the rewards of your approach.
Employees should consider the following:
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The IPO price: Was the IPO priced attractively, compared to the strike price of your options?
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Vesting schedule: When will the stock options fully vest? How could the IPO impact your ability to exercise them?
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Tax planning: What are the potential tax ramifications of exercising your options and selling your shares?
Summary
Stock options can be an attractive form of equity compensation whose value can significantly change in the wake of an IPO. While the change from being a private to public company can offer greater liquidity opportunities, it also brings potential challenges. Careful planning is key for employees seeking to maximize the potential of their stock options, as they endeavor to turn them into a viable financial opportunity.
If you want to learn more about how to sell your private company shares, please read this guide. Or, if you’re ready to get started, create a Forge account today.
FAQs about employee stock options when a company IPOs
Will I automatically profit from my stock options if my company is acquired?
Not necessarily. Profitability depends on the acquisition price compared to your exercise price. If the acquisition price is higher, you may benefit from a cash-out or favorable conversion. If it’s lower, your options may hold little or no value.
What happens to my unvested stock options in an acquisition?
The treatment of unvested options can vary. They could accelerate (vesting immediately), convert into new options with the acquiring company or be canceled. Terms are typically outlined in the acquisition agreement.
Can employees negotiate the treatment of their stock options?
In some cases, yes. Senior-level or key employees may negotiate better terms for their stock options. For most employees, however, treatment is determined by company policy and the acquisition contract.
