EXECUTIVE INSIGHTS: Tips to avoid tax traps in your company’s sale or IPO

By July 25th, 2023 No Comments

This article appears in Atlanta Business Chronicle.

When a company is being purchased or going through an initial public offering (IPO), executives and employees who received early-stage equity compensation should understand how their shares will be dealt with before, during, and after the transaction. It is not always what you think, and mistakes can be costly.

Pre- and Post-Sale or IPO Questions to Consider

  • What are your options or other forms of equity award shares as a percent of the company’s total outstanding shares? Are your shares being diluted due to additional rounds of funding?
  • What are the terms for unvested options/award if the company is sold? Are they canceled, accelerated, or forfeited if you lose employment on the sale?
  • What kind of options am I granted? Non-qualifed stock options (NQSO) or incentive stock options (ISO)?
  • If venture capital is there a separate class of “convertible preferred stock,” what are the preferred terms of that stock?
  • For an IPO, will they have to do a “reverse” stock split, and if so, how many shares will you have at the target price?
  • Do you have a “lockup” period, and how long (180 days is standard)?

Once the above questions are answered, deciding whether to exercise pre-sale or IPO options may be the next step.

Should I Exercise Pre-Sale or IPO?

If you exercise non-statutory options (NSO) before the sale or IPO, you will owe earned income tax on the spread without being able to sell the stock to pay the tax. Therefore, it’s important to have enough money to pay the taxes and to consider what may happen if the stock is less after the lockup period and your taxes exceed your gain.

Incentive stock options can be advantageous from a tax perspective but it’s important to consider the timing of exercise. While taxes are not due at exercise for ISOs, selling shares before a year and a day from exercise can trigger the alternative minimum tax or ordinary income tax. Did you exercise them in a time that would allow you to hold them for more than a year before the tax is possibly due? Would the potential lockup period prevent you from selling shares to pay the tax due on April 15th, the year following the exercise? Like NSO options, you have the risk of the stock value going below the taxes due during the lockup period.

If the stock option/award plan allows for it, you may exercise shares before they vest to start the clock for the capital gains holding period. Look at taking an 83(b) election within 30 days of the exercise and transfer of shares. Since the shares are illiquid and have little value upon a start-up, you want to make this election before the company starts additional funding rounds.

One should understand if the stock option plan has repurchase rights in the plan agreement, which requires the employer to repurchase the shares through the repurchase rights provisions in your grant; this agreement can be used for unvested or vested shares. You may forfeit the shares without repurchase rights when separating from the company before vesting. You will also need to understand how the repurchase right determines the share price.

A company sale can create great wealth, but without proper planning, one can find themselves in difficult tax situations and much less wealth than they were counting on.

Before your company is sold or becomes public, work with someone who understands the intricacies of tax and equity compensation issues regarding company sales or IPO. That way, they can help you maximize what you keep, protect your hard-earned wealth, and leverage it to support what matters most to you— now and in the future.

Are you interested in working with someone who understands the tax and equity compensation issues associated with a company sale or IPO? Contact Dan Dubay, Director of SignatureExecutive, today!

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