Liquidity Events

Your venture-backed company is growing, and you’re hearing rumors of a potential public listing. Preparing for an IPO typically takes 18–24 months, as companies need to align their accounting practices with public company standards. A public company faces stringent financial reporting and regulatory requirements, which often necessitates hiring a new CFO or another executive with public company experience to spearhead the effort. This process includes updating accounting practices and implementing robust financial controls.

During the pre-listing - but very likely-to-list period - let’s call it the pre-liquidity period - there are a few financial planning techniques that you should consider.

Pre-Liquidity Event

As an important disclaimer, remember that being “likely to list” or “rumored to list” does not guarantee a liquidity event. The risk of pre-liquidity planning is that there’s a possibility the liquidity event may never happen. Keep this in mind as you evaluate your strategies.

Managing your equity

During the pre-liquidity period, you may consider exercising as many options as possible, provided you're optimistic about the eventual liquidity event. Exercising your options into shares before the IPO can help you save on taxes, but it also comes with the risk of incurring a large out-of-pocket tax bill. Benefits from exercising early include starting the clock on your holding period, which could qualify the appreciation for long term capital gains tax treatment. While this approach can reduce your tax burden, it carries higher risk, as there is no guarantee that your company will have a liquidity event.

If you exercise your shares at a low strike price compared to their fair market value (i.e., 'in the money'), you may trigger the Alternative Minimum Tax (AMT), potentially facing a substantial tax liability. For instance, exercising options costing $50,000 could lead to a $1,000,000 tax bill. To reduce this risk, consider exercising options with strike prices closer to the current market value, minimizing the taxable bargain element. This approach keeps future gains unrealized and untaxed until you sell the shares, likely sometime after the IPO. Due to the complexity of these tax implications, we strongly recommend consulting a financial advisor or tax professional before making a decision.

You may also explore external financing options. These offerings provide upfront funds to finance an exercise and cover taxes, with the expectation that they will be repaid once the company successfully goes public and you can sell your shares. Some of these loans are “recourse,” meaning that if the company does not successfully IPO, you are still obligated to repay the lender the money plus interest. Others are “non-recourse,” where if the company fails, you owe nothing, and the lender absorbs the loss. Understandably, non-recourse loans are generally more expensive and take a larger share of your proceeds after the public market sale.

• Recourse options financing loan – you are personally liable if the company fails or doesn’t IPO. These loans typically have lower costs but are harder to obtain, as they require strong creditworthiness.
• Non-recourse options financing loan – You are not personally liable if the company fails or doesn’t IPO. However, these loans come with higher costs, as the lender assumes more risk. Your personal creditworthiness is less of a factor in approval.

Estate planning

You may consider using an irrevocable trust as a tax planning strategy, particularly if your estate exceeds the exemption amount (currently $27.98M for couples and $13.99 M for individuals). By transferring shares to an irrevocable trust, those shares are removed from your estate, and any future appreciation (which you anticipate at the IPO and beyond) will not be subject to estate tax at your death. There are various types of trusts to consider, so it's important to consult with an attorney and conduct further research to determine the best fit for your situation.

Philanthropy

During the pre-IPO period, it's generally not advisable to transfer shares to charity. You will likely incur taxes associated with the liquidity from the IPO, which may result in a large tax liability that year. Timing a large charitable donation to coincide with an income spike and the associated tax liability can help minimize the taxes paid in that high-income year. Additionally, since the value of the shares is expected to rise leading up to the IPO, waiting until after the IPO to make charitable gifts allows for more appreciation, a larger gift, and a bigger tax deduction. Public company shares are also much easier for charities to handle, offering more flexibility in how you structure your gifting. If your company is actively preparing for an IPO, it’s usually better to wait until after the IPO to make stock-based charitable contributions, although you can still contribute if the company doesn’t go public. Consider setting up a donor-advised fund or another structure to maximize your philanthropic impact.

The Liquidity Event

As an employee shareholder, you typically won’t have many choices for the actual liquidity event. Companies often take one of the following popular routes: initial public offerings (IPOs), direct listings (DPOs), or special purpose acquisition companies (SPACs).

IPOs (Initial Public Offerings)

You may be given the opportunity to sell some of your shares in the IPO, but that is not guaranteed. The company will hire investment banks to facilitate a coordinated sale to public investors, and after that, the public investors will trade shares among themselves. However, the company and its early investors will sign lockup agreements, promising not to sell stock for a period of time. As an employee, you will generally be subject to the lockup terms. If you are not an employee, you may not be subject to the lockup period, but that isn’t always the case.

As an employee shareholder, your primary liquidity event—where you can sell your shares for cash—typically occurs after the lockup period ends, rather than on the IPO date. The IPO itself is a major liquidity event for the company, as it raises capital by selling newly created shares to the public. Existing investors may also gain liquidity by selling their shares. However, most employees are not granted the opportunity to sell during the IPO, as the shareholders permitted to do so are usually limited to institutional investors, top executives, or company founders.

Regardless of whether you can sell in the IPO, it's important to develop a long-term plan for your shares once liquidity becomes available. Will you hold onto all your shares? This might make sense if you already have significant external liquidity. Or will you sell all your shares? That could be a good option if you're looking to retire early or pursue other financial goals.

A regret-minimization approach typically involves selling a portion of your shares—or a specific dollar amount—at the first available public liquidity event while retaining the rest to sell gradually over time.

Even if you take no action, an IPO can result in a significant tax liability if you’ve been granted RSUs. Fortunately, these taxes are typically withheld at the time of vesting, so you won’t need to pay out of pocket—but you are still paying them. This is due to double-trigger vesting, where RSUs don’t convert into shares (and trigger taxes) until the company goes public. 

Pre-IPO, this structure benefits employees by preventing tax liabilities on illiquid private stock. Once the company is public, shares can be sold to cover taxes upon vesting. However, this also means that when your RSUs vest all at once at IPO, the full value is treated as ordinary income subject to withholding. As a result, your post-tax share count will be lower than the pre-tax RSUs you originally held.

When a company goes public through an IPO, it achieves two key objectives. First, it transitions from a private company to a public one, gaining share liquidity and taking on additional regulatory requirements. Second, it raises capital by selling newly created shares to investors. Historically, the primary goal of an IPO was to raise money, but in today’s market, the ability to provide liquidity to existing shareholders often takes precedence. In some cases, companies bypass the fundraising aspect altogether and opt for a direct listing, where no new shares are issued—only existing shares are made available for public trading.

Direct Listings (DPOs)

Direct Listings function similarly to IPOs but without a large, coordinated share sale. The company still undergoes the regulatory process to become publicly traded, gaining the benefits of public status—most notably, increased share liquidity. However, unlike an IPO, no new shares are created or sold by the company. Instead, existing shareholders can list their shares on a stock exchange, allowing public investors to buy them.

As with any publicly traded stock, an opening auction determines the market-clearing price each morning. Buyers place orders, sellers list shares, and the exchange matches them through an iterative pricing process.

As an employee shareholder, you may have the opportunity to sell your shares in a Direct Listing. However, your company may impose trading restrictions that limit when and how you can sell. Non-employee shareholders are generally able to sell their shares immediately, but certain circumstances could still impose restrictions.

If you have a significant number of vested but unexercised stock options, accessing cash becomes much easier once your company is public. Pre-IPO, covering the cost of exercising options—and potential taxes—can be challenging. However, after the IPO, you can use a “cashless exercise,” where shares are sold in the public market to generate the cash needed for both the exercise cost and taxes. This allows you to efficiently convert your options into cash if desired.

Special Purpose Acquisition Companies (SPACs)

A SPAC (Special Purpose Acquisition Company) begins by conducting its own IPO, raising capital that is held in a trust while the SPAC searches for a private company to take public. Since the SPAC itself has no business operations—only a pool of money—the regulatory process for going public is simpler. Once the SPAC identifies a target company, it negotiates a merger agreement, through which the private company gains access to the SPAC’s funds along with additional capital from institutional investors. This process, known as a “de-SPAC merger,” allows the private company to go public without the traditional IPO route.

Post Liquidity Event

Once you’re able to sell, it’s likely that you’ll want to sell some shares to diversify your portfolio. As the saying in investment management goes, "concentration makes you rich; diversification keeps you rich." While some individuals may be eager to sell and cash out, many are reluctant to reduce their concentrated position. This can be due to emotional attachment, a desire to defer taxes, or the belief that the stock price will continue to rise. It can be challenging to part with shares in a company to which you've devoted so much effort, energy, and time.

Relying too heavily on a single company to achieve your financial goals can make it more challenging to reach those goals. If the company faces problems or the stock price declines, it could jeopardize your long-term financial plans. Additionally, if you are still working for the company, your job could be at risk while the stock value drops. Putting both your income and wealth in one company places all your eggs in one basket. To mitigate these risks, investors generally should reduce their exposure to a concentrated stock position. At a minimum, taking enough out of the basket to sustain your lifestyle while leaving only "discretionary" money fully at risk is advisable.

Once liquidity is available, it’s important to explore financial, tax, and legal strategies to preserve your wealth responsibly and help you achieve your goals. For example, you’ll likely need a diversified investment portfolio, a revocable trust, life insurance, and a CPA to help with tax filing.

Conclusion

Navigating the pre- and post-liquidity event periods requires careful planning and strategy. Whether you are managing the potential tax implications of exercising stock options, considering estate and charitable giving, or making decisions regarding your post-IPO investment strategy, it’s crucial to understand the financial tools available to you. While the excitement of liquidity may be appealing, balancing your portfolio, minimizing risks, and aligning your decisions with your long-term financial goals are key to preserving and growing your wealth. Seeking professional advice and continuously evaluating your financial position can ensure that you make the most of this significant life event.