For company founders, going public can mark the transition from building the value of a business privately to stewarding it in full view of the public markets. Whether through an IPO, direct listing or SPAC merger, it’s a milestone worth recognizing—but the months leading up to it tend to be fast-moving and unforgiving, with pivotal choices around liquidity, equity and taxes that are difficult to revisit once the window passes.
Founders often think of an IPO as the main milestone, but it is one of several liquidity events that can affect both business strategy and personal wealth. Here’s what you should consider for your business and personal wealth.
What is a liquidity event and how should founders prepare for one?
A liquidity event is a transaction, such as an initial public offering (IPO), direct listing, Special Purpose Acquisition Company (SPAC) merger, or secondary sale, that allows founders, employees and investors to convert private company ownership into cash or publicly tradable shares.
Founders should prepare well before a transaction by:
- Reviewing their equity ownership and legal papers
- Updating their tax and estate planning documents
- Understanding potential lockups or sale restrictions
- Assembling a team of legal, tax, banking and Financial Advisors to help manage the business and personal impact of the event
What are the differences between a traditional IPO, a direct listing and a SPAC merger?
Companies generally have three main paths to enter the public market: an IPO, a direct listing or a merger with a SPAC.
- A traditional IPO is when a private company sells newly issued shares to the public through underwriters, raising capital while the banks help market, price, allocate and manage the offering. It is the most common and standard way for a company to go public.
- A direct listing is when a company lists existing shares directly on an exchange, allowing existing shareholders to sell stock publicly, typically with less underwriter involvement and often without the same capital raise, book-building or lock-up structure as a traditional IPO.
- A SPAC merger is an alternative path to going public, where a private company combines with an already-public acquisition company.
Regardless of the transaction path, founders who expect a liquidity event should begin planning before the deal process is already underway.
I'm selling my company next year. How do I plan for the liquidity event and tax impact?
If you expect to sell your company next year, it’s worth planning before the deal is underway because the timing, structure and valuation of the transaction can materially affect your tax outcome. Here are four ways a founder can prepare.
- Start pre-liquidity tax planning early. Review strategies like exercising employee stock options early—before an IPO or other liquidity event—so that any future appreciation is potentially taxed at more favorable long-term capital gains rates, rather than at the ordinary income rates. Be sure to weigh the upfront cash cost and the possibility that the shares may decline in value. Another option to consider is a qualified small business stock (QSBS) exemption. Because timing can affect which strategies are available with QSBS, early planning is essential. If you and your company satisfy the requirements, QSBS may allow you to exclude a significant portion of capital gains from your taxable income.
- Understand what type of equity you own. Outright shares, incentive stock options (ISOs), non-qualified stock options (NQSOs), restricted stock units (RSUs) and restricted stock can receive different tax treatment and at different times, including potential exposure to ordinary income rates, capital gains rates, or Alternative Minimum Tax (AMT) liability. Additionally, it may be helpful to understand your company’s 409A valuations, as they may be lower than the preferred valuation, which can come into play when estimating the potential tax impact of exercising options.
- Coordinate income tax, estate and charitable planning while the company is still private, since gifting or transferring shares before a liquidity event may create more planning flexibility, though these strategies require careful legal and tax review. For example, if you plan to gift a million shares of company stock with a fair market value (FMV) of $1, you will have used $1 million of your lifetime federal estate and gift tax exemption. In the event that the stock later IPOs at $10, you will have gifted shares eventually worth $10 million to your beneficiaries but have exhausted only a fraction of your lifetime exemption.1
- Remember that liquidity often comes in stages, not all at once. In other words, going public does not necessarily mean immediate access to cash: Tender offers, IPO lock-ups, direct listings, SPAC mergers, trading windows and company policies can all impact when—and how much—a founder can actually sell.
When it comes to your personal wealth, it’s important to understand how lock-up periods can affect market expectations and potential stock-price volatility.
How do lock-up periods affect the trading of IPO shares?
Lock-up periods can affect the trading of newly public shares by temporarily limiting when insiders—such as founders, employees, executives and early investors—can sell shares after a company goes public, with many lock-up periods lasting around 180 days.
How do lock-up periods affect post-IPO stock prices?
When the lock-up period expires, a large block of previously restricted shares may become eligible for sale, which can increase trading volume, create selling pressure and lead to stock-price volatility or decline if investors expect insiders to sell. The price impact is not automatic; it depends on the size of the shares unlocked, market expectations, company performance, insider behavior and whether investors view selling as normal diversification or a negative signal.
Working with your Morgan Stanley Financial Advisor
Going from private founder to public company insider is a career milestone that leads to more complex planning needs, including additional tax considerations, trading limits and life-planning decisions, all at once.
Your Morgan Stanley Financial Advisor and equity planning specialists can help you make coordinated decisions, including whether to consider an early exercise, how to evaluate potential QSBS benefits, how to approach an 83(b) election, and how to plan around post-IPO selling restrictions.
With a full plan in place, you can make these decisions with more confidence and reduce avoidable surprises.
To learn more, ask your Financial Advisor or Morgan Stanley representative for a copy of the Global Investment Office report, What to Expect When You’re Expecting to Go Public by Steve Edwards.
