Are You That Lucky Employee With an IPO Windfall? If you are, then don't lose it. Instead, plan wisely. Here are five ways to do that.
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Considering the more-than-140 startups that are presently valued at over $1 billion apiece, even junior employees may become overnight millionaires these days.
And since this will likely be the most important financial event that ever happens to those junior employees-- or you, should you be that lucky -- it's crucial that you develop a plan to preserve your newfound wealth.
"Lightning doesn't always necessarily strike twice," says Yvette Butler, president of Capital One Investing in McClean, Va. "Be very prudent when these things happen, and you come into money. Don't draw a straight line from that experience to the rest of your career."
In fact, if you do benefit from an IPO, you may not have the luxury of time to figure out what to do. But the first thing that will happpen is that your company leadership will communicate the deal's details to you. There'll also be a registration process and "roadshow" to signal that the IPO is actually imminent. "That's when you know your company is serious about this and you have an idea of what your allocation is," says Jeanne Flynn, first vice president, wealth management, at Merrill Lynch in Irving, Calif.
Once the event nears, you can begin to plan for what to do with your potential windfall.
1. Do your homework.
"There are a lot of things that individuals need to understand about their options far in advance of any liquidity event, to mitigate different risks and limit tax liability," says Katherine Dean, managing director of wealth planning at Wells Fargo Private Bank in San Francisco.
One thing to know is that you may be restricted on how much of your company stock you can sell at any given time, because of the company's internal policies, insider trading rules and lockup periods. These periods can last between 90 and 180 days, to prevent any flooding of the market.
Understand what you're being granted, too. "Know if they're incentive stock options and have more restrictions on how the plan could be structured -- but there are tax advantages that come into play," says Karen Goodfriend, certified public accountant and principal at KK Wealth Advisors in Los Altos, Calif. What you're granted and how long you hold on to the security, as well as when you sell, will affect your tax liability.
2. Plan for the future.
Developing a long-term wealth plan will help you figure out how your balance sheet will change, as well as how to limit your tax liability in an efficient way. No matter your age, set some goals for what to do with this newfound money so you don't spend it frivolously.
Whether you plan to continue working or to do something different with your time, you'll want to invest your money accordingly. "It's about understanding your goals and fitting a portfolio that's going to match these goals and also match your risk tolerance," says Flynn.
You have to make choices so you know what you want to accomplish with these funds, too. "To the extent that you can take care of longer-term things like buying a home, taking care of education or saving for retirement, you can accomplish these things depending on how much you make," says John Lisy, certified financial analyst and senior portfolio manager at UBS Wealth Management, in Chicago.
What you'll learn, if you're smart, is that money does buy freedom and security. So, the first thing to do if you don't already know, is to spend time figuring out what makes you happy. "If you don't know what makes you happy, additional money won't help that," says Craig Brimhall, vice president of wealth strategies at Ameriprise Financial, in Harrisonburg, Va.
3. Manage your expectations.
Market fluctuations can affect the value of your shares. "You may find out that you're appreciably less wealthy than you think you are because of restrictions in your ability to sell shares or market movements that aren't in your favor," says Brimhall. "Even if the price is good, you might be restricted in the number of shares you can sell."
Since the value of your shares can be affected by declining stock prices, don't rely on selling stock to fund a major purchase. Instead, plan ahead for these purchases so that you don't lose both the asset and your windfall because of a market fluctuation.
4. Assemble a team.
"You'll want to have an accountant, financial advisor and an attorney," says Lisy. "They can help to structure things that will minimize taxes and protect you from a legal standpoint."
While your name may be listed in public documents and easy to find, don't take calls from just any advisor. Ask for recommendations from people in your inner circle instead.
With this money, you may also experience different emotions that range from joy to the sense of being overwhelmed. A team can provide an objective third-party opinion so that you don't fall into certain patterns and are able to maintain your wealth and your relationships.
"This money can affect relationships, because friends and family start asking for help," says Goodfriend. "If [IPO beneficiaries] have an advisor, they can always use that as an opportunity to use that person as a trusted advisor -- it's very easy to fall into that trap of being a checkbook."
"When you're paid in stock and have all your eggs in one basket, you have to figure out how much of your wealth you want tied to this company," says Flynn. "That's considered a concentrated position and might be 15 to 20 percent of someone's net worth, but that comes down to what makes the person most comfortable."
While holding on to stock in the company can turn out well, there's also a lot of risk to this strategy. "There are a lot of events we can point to -- think back to the dot-com crash," says Dean. "Unfortunately, not everyone diversified, and they went from being a multimillionaire overnight to having nothing. There are no guarantees that a stock price will increase after an IPO, and you have to plan for this."
While under-diversifying can actually create wealth, you should do that only with excess funds. "Financial planning would tell you that you should diversify enough to take care of your needs and then you can leave the rest in your company if that's what you want to do," says Brimhall.
Do take your time to invest your money away from your core position since most of the success from investing is diversification. "The sooner you diversify, the more time that that wealth has to grow to fund your retirement or other life dreams," says Butler.