Working at a startup is incredibly rewarding; you get to build something from scratch, turn an idea into reality alongside driven colleagues, and potentially change an entire industry for the better. If you own equity in the company, an initial public offering (IPO) represents the ultimate chance to monetize all that hard work. However, deciding what to do with your stock, maximizing your benefits while minimizing taxes, and transforming a sudden windfall into lasting wealth introduces a whole new level of financial complexity. While this guide is not entirely comprehensive, we have put together a quick checklist to get you planning if your IPO is shifting from “someday” to “someday soon”.

What Kind of Stock Do You Own?

Pre-IPO equity can take several different forms:

• You may have been granted stock outright that you fully own right now and can sell as soon as the lock-up period ends.
• You might hold restricted stock units (RSUs) that must vest over time.
• You may have employee stock options that must also vest before they can be exercised.

The specific type of stock you hold will dictate when you are allowed to sell it and what taxes will be due.

Breaking Down the Types of Stock Options

The most common type of stock options are non-qualified stock options (NSOs). These options grant you the right to purchase a pre-set number of company shares at a specific, pre-set price. The goal is for the stock’s value to increase, allowing you to reap the financial difference when you sell the shares. With NSOs, taxes must be paid when the options are exercised (when the shares are purchased) and again when the shares are sold, assuming the stock has appreciated. NSOs are generally taxed as ordinary income.

Conversely, incentive stock options (ISOs) give you the right to buy shares at a discounted price while delaying taxes until the shares are actually sold. ISOs are usually taxed at the much more favorable capital gains rate, meaning that exercising the option and holding the stock for at least one year can potentially create a significant tax advantage.

Stock options typically follow a strict vesting schedule, meaning they cannot be exercised until they vest. Once vested, you do not have to purchase them immediately, but there is usually a strict expiration date by which you must exercise them, or they expire.

RSUs operate differently: they are a direct transfer of stock from your employer to you that vest at a later date. Once they vest, you own the stock outright and can do whatever you want with it. It is essential to remember, however, that the fair market value of those RSU shares is included in your taxable wages. Often, this taxable event does not occur until after the shares vest and the company officially IPOs.

What’s the Timeline?

Most IPOs enforce a lock-up period, which usually lasts at least six months. You will be completely unable to sell your shares during this window, and IPO share prices can bounce around a lot. It is absolutely crucial not to count your proverbial chickens; in other words, do not spend the money before you actually have it. A lot can happen in the market, so you need to stay within your normal budget, stick to your standard savings plan, and avoid committing to any massive expenditures.

When exercising options, a common tax-minimization strategy is to hold the stock long enough for the sale to qualify as a long-term capital gain. This lower tax rate applies to assets that are held for at least one year. For options specifically, two years must have passed since the original date the opportunity to buy the shares was granted. For example, if you exercise your option six months before the IPO, you begin your one-year holding period; once the six-month post-IPO lock-up is over, the resulting sale should count as a long-term capital gain. However, it is always more important that the stock sale fits logically into your overall financial picture than to hold yourself to a strict timeline.

Diversification is Important

A concentrated stock position is generally defined as making up 10% or more of your total investment portfolio. Depending on your overall financial position, continuing to hold a massive percentage of your personal wealth in your employer’s stock can be very risky. Selling a portion of your concentrated position and redeploying those funds into a more diversified portfolio of assets makes good financial sense.

This diversification can act as part of a strategic plan to get you closer to early retirement, or it can serve as a way to express your personal values and beliefs outside of work if you choose to invest in ESG-focused stocks or funds. You might also decide to use the liquidity to get ahead of some big expenses. For instance, you could choose to super-fund 529 education plans for your children or totally pay off outstanding student loans. The main idea is to be highly thoughtful about your complete financial picture and to make a plan for those new funds that will keep you on track.

The Bottom Line

A potential IPO brings your hard work and professional goals to fruition in a very tangible way. But before you can start enjoying the monetization of your vision, it is a very good idea to have a comprehensive financial plan firmly in place. Successfully navigating this transition requires advice from seasoned experts who can objectively consider your company, your tax picture, your other assets, and your ultimate life goals.