As Lyft, Uber, Pinterest and other Bay Area tech companies go public, their employees with stock or options will have to make a potentially life-altering decision: whether to cash in or hold onto company stock.
Most financial advisers recommend selling stock after any lockup period expires and using the proceeds to diversify into other assets, pay off high-cost (over 6 or 7 percent) debt, start an emergency or college fund, buy a home or boost retirement savings.
Holding any single stock is risky, and if the stock makes up a big chunk of your net worth, it’s even riskier. If the stock is also the company you work for, it’s downright treacherous, because if the company fails, you could lose your nest egg and your job. “Concentration makes you money, diversification helps you keep it,” said Shannon Lynch, a senior adviser with Personal Capital.
Yet many employees are reluctant to cash in IPO riches. Some see it as disloyal. “It’s like cheating on your partner, so to speak,” said Hersh Shefrin, professor of behavioral finance at Santa Clara University. Or they think they know the company better than outsiders do, which is usually a mistake.
In the late 1990s, Jim Titus was working in Boston for a firm called AdSmart that was acquired by Internet sensation CMGI. It had stakes in dozens of high-flying companies including Alta Vista, Lycos, Geocities, Snapfish and Raging Bull. “They were a big deal. Our CEO was on the cover of Barron’s, the Wall Street Journal, every week it seemed,” he said.
Titus got CMGI stock that he was sure would make him a millionaire. He and his colleagues “were incredibly optimistic. I’m in my 20s, this represents a good portion of my wealth. We were pricing out what new vehicles we were all going to buy, looking at different apartments or homes we were going to buy,” he said.
Titus held onto about half his CMGI stock and reinvested the rest, mostly in other tech stocks, thinking he was diversified.
“Then 2000 rolled around, the stock market collapsed,” he said. After soaring almost 1,000 percent in 1999, CMGI stock lost 96 percent of its value by the end of 2000. He was in San Francisco by then, and “it seemed two out of three of my friends were all unemployed.”
Experts’ tips for IPO riches
Here are five suggestions for employees with stock or options in their company:
Know what you own: Incentive and nonqualified stock options, restricted stock and restricted stock units all have different rules and tax consequences. People who don’t understand them can wind up with missed opportunities and tax headaches. Mystockoptions.com has a wealth of information on stock compensation. So may the firm that administers your employer’s stock plan. Wealthfront has a primer at https://blog.wealthfront.com/equity-ipo-guide.
Get professional help: Find a tax or financial adviser familiar with equity compensation who can help you minimize the tax burden and diversify your assets. Many financial advisers will give an initial consultation for free. Ask if your financial adviser will act as your fiduciary in all dealings. If the answer is no, head for the exit.
Set a goal: “People who are happiest with their equity compensation have set a goal for those proceeds. When they have that amount of proceeds, they sell the stock to fund that,” said Bruce Brumberg, editor of Mystockoptions.com.
Review insurance: As your assets grow, you may want extra liability insurance that will protect them if you get sued. An umbrella policy will provide additional coverage beyond the limit on your homeowners, renters or auto policy. “It’s generally very inexpensive for the amount of coverage they provide,” said Jim Titus, a financial consultant with Charles Schwab. Also ask yourself if you still need life insurance, he said. “If you have a $1 million life insurance policy and your net worth is now $2 million, do you need the $1 million policy?”
Share the wealth: If a windfall pushes you into a higher tax bracket, consider making tax-deductible gifts to charity. Not sure which charities? You can set up a donor-advised fund at a public charity and make an irrevocable donation — and get the deduction — in your high-tax year. Then you can recommend which individual charities should get grants from your account over time. For the good of charities, just don’t wait forever.
In the end, Titus was left with 10 percent of what he initially expected. “I never bought a house, never bought the car.”
Titus vowed that if he came into a windfall again, he’d know how to manage it. In 2002, he became a stockbroker at Morgan Stanley, so he could learn about investing while he was getting paid.
In 2004, a lot of his clients were asking about Google, the most hotly anticipated IPO since the dot-com debacle. The woman he was dating (now his wife) also worked there and had shares. Google went public in August 2004, and its stock popped 18 percent the first day. By the time her 180-day lockup period expired, the stock had doubled. “It’s a good thing we couldn’t sell on the first day,” Titus said.
After the lockup, “we sold some to cover taxes and put a little nest egg aside, a little emergency money.” They made a plan to sell a certain percentage of her holdings every quarter. Although Google has continued to go up, Titus has no regrets. “Some got invested in Apple, some in other stocks that have appreciated as much as Google did. We put a down payment on a first house, did some really great things with that money. It paid for our wedding in 2006.”
Today, Titus is a financial consultant for Charles Schwab in San Francisco, where he often helps clients manage newfound wealth. “One thing that worries me ... is that a lot of people haven’t experienced a downturn like we had in 2000 and 2008,” he said.
Schwab and other firms generally recommend that investors hold no more than 20 percent of their net worth in a single stock. Titus tries to get clients to agree to sell a certain amount of stock on certain dates, regardless of the price. But many balk. “The only clients willing to sell a significant portion are the ones who have been through previous IPOs,” Titus said.
Andy Rachleff, CEO of Wealthfront, an online money management firm, said that most of his clients with company stock hold it, even though “for the vast majority of companies, you would be best served selling as soon as the lockup period ends.”
He believes employees hold for one of three reasons: They don’t know what to do, so they do nothing; they don’t want to regret having sold the stock if it goes up; or they feel disloyal.
Many employees receive restricted stock units that vest, or become unconditionally owned by the employee, over a number of years. “From a tax perspective, this is like getting a cash bonus,” Rachleff said. The value of the units on the day they vest is taxable as ordinary income, whether or not the employee can or does sell the stock.
If an employee got a $50,000 bonus, “I bet less than 10 percent would buy the stock,” Rachleff said. But if they get $50,000 in stock, most will hold it, “which is the equivalent of buying the stock.”
Fidelity looked at the selling behavior of employees in stock plans it administers who had restricted stock vest at any time in 2017. On Jan. 1, 2019, about 46 percent still held all of those vested shares, 46 percent had sold them all and 8 percent had sold some. “The greater the value of the payout to the employee, the more likely they were to sell,” said Fidelity’s Emily Cervino. Fidelity didn’t break out this data just for newly public companies.
“My advice to most employees with options or restricted stock is to sell and diversify,” said Jay Ritter, a finance professor at the University of Florida who has studied IPO performance. “If the company stock or options are a bigger proportion of the employee’s assets, selling sooner is better.” With options, however, “the further away the maturity date, the better it is to hold longer. And if the current market price is only a small amount above the exercise price, it is better to wait, since there is more upside potential and relatively little will be lost if the stock price drops.”
Jamie Still, 40, joined LinkedIn as a web developer in 2007 and was given options to buy stock at a low price. He exercised them and purchased the stock almost immediately, using a strategy known as an 83(b) election that lets you prepay your tax liability on a low valuation. But it’s not without risk.
As LinkedIn’s IPO in 2011 drew near, Still hired an adviser who helped him with financial and tax advice. “They were pretty adamant I diversify,” he said. “The windfall from LinkedIn dwarfed anything else I had saved up to that point.”
Still sold all of his LinkedIn stock not long after the lockup period expired. He reinvested in “a properly asset-allocated portfolio for my risk profile,” he said.
He also invested in a local real estate company that was flipping houses, but got out because “it was too risky for what I was getting back.” He put a large down payment on a condo in San Francisco that he rents out.
In 2012, he left LinkedIn to join Lyft, where he got more stock options. In February 2016, Still “decided to take a break from Silicon Valley.” He bought a catamaran, which he has been sailing around the Caribbean.
He’s not sure what he’ll do when Lyft goes public. “I believe in the management, the product,” but there are “definitely regulatory risks and a colossal competitor,” he said. “It’s the same dilemma I faced before: Do I want all my eggs in one basket? How soon should I liquidate?”
Looking back, Still says he might have “slowly unraveled” his LinkedIn position instead of selling all at once. “I did quite well, but had I held all the way to the purchase of LinkedIn by Microsoft, I would have done much better,” he said. “The thing with IPOs, you will never time it quite right. You can’t beat yourself up.”
Still encourages other employees at startups to get tax and financial advice as soon as possible. He was lucky that someone at LinkedIn pulled him aside early on and told him about the 83(b) election, which he also used at Lyft. This can be a good strategy if you join a company when the stock value is very low, but gets riskier as the value goes up. If the company never goes public or gets acquired, you may never be able to sell the stock you have purchased.
Not all companies let employees exercise options before they are vested, said Barbara Baksa, executive director of the National Association of Stock Plan Professionals. Employees can also do this with restricted stock but not restricted stock units, she added.
Still said he’s been “very fortunate.” If the Lyft IPO is successful, he’ll keep sailing for a while. “If it’s not, I don’t know if I will go back to Silicon Valley or do something completely different. This could all end. I have to keep reminding myself not to depend on Lyft’s IPO.”
Kathleen Pender is a San Francisco Chronicle columnist. Email: [email protected] Twitter: @kathpender
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