Pre-IPO Financial Planning Tips

There's no such thing as too early when planning for a liquidity event, but if you're like most founders, you likely haven't taken time to plan for the impact on your personal finances.

If you're within 12 months of a possible initial public offering, or IPO, it's important to take steps toward attaining the best outcome for building your personal wealth. Even before you start interviewing underwriters, identify a financial advisor experienced in planning around IPOs or mergers and acquisitions, consult tax and estate planning professionals and prepare a strategy well in advance. Here are a few key questions to help you plan.

What are your goals?

In order to make decisions around exercising options or transferring wealth—either via irrevocable trusts or philanthropic planning—it's important to understand the risks and tradeoffs. While tax minimization may be part of this plan, keep in mind that exercising options early and transferring wealth each may have major tax implications. Setting goals and identifying priorities with your advisors will help guide your decision-making.

What tax exemptions are most relevant?

If you're a founder, angel investor or employee of a successful early-stage company, part or all of your shares may be eligible for qualified small business stock, or QSBS, exemptions, which may protect up to $10 million—or 10 times your cost basis, whichever is greater—from federal taxes. To determine this, you need proper documentation. Ask your company auditor or accountant to prepare a memo identifying which shares on the cap table may qualify. Understanding these tax implications is critical before you make decisions on how and when to trade, transfer or gift these shares.

Is it better to exercise or hold stock options?

Deciding when to exercise incentive stock options, or ISOs, is critical and should be reviewed near the end of each year. The ability to exercise ISOs without paying alternative minimum tax, or AMT, is a great incentive, and the benefits may change from year to year depending on your personal tax situation. Ask your tax advisor to model the cost of exercising versus the expected gain from achieving long-term capital gains on the shares.

A key milestone to consider is when your company moves from getting annual to quarterly 409(a) valuations. This is often the point when the price spread between common and preferred shares narrows rapidly. It's also important to recognize that while exercising options creates an opportunity to minimize taxes, it also may mean taking on additional risk. For example, you may choose to hold your options risk-free until the expiration date, and if you go public, sell the shares simultaneously with the exercise to mitigate risk. Of course, this will likely result in paying a higher tax rate on the gains.

How will liquidity activity affect estate planning?

If you don't have one already, this is a critical time to create a basic estate plan that includes a will, living trust, healthcare directive and financial power of attorney. You'll need these pieces in place before you begin any advanced estate planning. Consider your goals carefully before deciding which type of trust structure to put in place.

Much like stock option exercises, this may be one of the best times to take advantage of wealth transfer strategies. The Tax Cuts and Jobs Act of 2017 increased lifetime gifting and estate tax exemptions—$13.61 million for an individual and $27.22 million for a married couple for 2024—adjusted for inflation. However, these higher exemption levels sunset at the end of 2025, so consider this timeline in your planning.

How do I time liquidity?

Some companies allow founders to participate in selling shares on the day of the IPO, but you may not be able to sell shares until the end of the underwriters' lockup period that typically restricts sales until 6 months after the IPO. If you're still with the company 6 months later, you'll also likely be subject to internal trading windows that may be closed at the end of the lockup period, which may delay your access to liquidity.

But there are tools to tap into liquidity in advance, including a bridge loan or restricted stock loan just prior to the IPO. You may be able to pledge shares to obtain a loan before an IPO. However, this may not be the case post-IPO if you're an employee. That's why understanding your liquidity and cash flow needs ahead of time is so important.

While you might be tempted to assume your company's stock will only go up, it's a good idea to recognize the potential downside risk. Many things outside the control of a company—such as recessions, black swan events and changing business environments—have the potential to significantly impact your wealth. It's important to devise a diversification strategy to reduce concentrated positions and stick to your liquidity plan.

How can I gain more flexibility?

First, you need a clear understanding of your limitations on selling shares post-IPO. Will you be a Section 16 officer or an insider? Either way, you'll likely want to use a 10b5-1 trading plan. This type of plan typically requires liquidation planning a year out or longer, but it allows you to sell shares in the future regardless of trading windows.

Companies going public generally put tight restrictions around your ability to implement such plans. It's a good idea to begin thinking about the plan post-IPO but before any lockup ends.

At this point, you may have more visibility into where the stock is trading. You'll want to work with your advisory team to craft a strategy that considers your financial goals, tax implications, grants expiring within 2 years and future grants.

When do I devise an investment strategy?

Before you trade shares, it's important to have an investment strategy in place—and portfolio diversification is highly advised. A strong plan establishes desired liquidity levels first, then sets the investment decisions. That's why it's critical to consider your long-term goals to properly fund an investment strategy. The more disciplined you are in applying the strategy, the more likely you are to reach those goals.

How can I approach charitable giving?

This may also be a good time to consider a charitable giving plan. Accounts such as donor-advised funds and charitable giving funds allow you to make contributions in high-tax years but then spread out the gifts over a period of time. By gifting stock, you can often avoid paying taxes on large gains and keep that money in the fund.

If you're considering a significant wealth transfer through philanthropy, you may want to look into a private foundation. Keep in mind these are complex decisions with significant implications for pre-IPO tax planning and your personal finances, so you should consult your tax advisor to explore your unique situation.

The bottom line

When planning for an IPO and its impact on your personal finances, it's important to assess both risk and reward. Focusing solely on tax minimization may result in downplaying the reality of risk to your wealth strategy. Setting goals and identifying priorities can help you gauge your tolerance for risk, cost and complexity. As always, leveraging the strength of an experienced team of wealth professionals can help you stay on track and start the next chapter with a clear vision.