Strategic Selling of Equities (Pre-IPO): Navigating Real-Life Scenarios
For investors and high-income earners, the sequence in which they sell their equity holdings can have significant tax implications. This guide provides a straightforward approach to determining a tax-efficient order for selling various types of equities, from stock options to long-term investments, if the company is not public yet.
By strategically prioritizing sales based on these real-life scenarios, you can minimize tax liabilities and maximize financial returns. Additionally, please refer to the section further below to learn what to consider if your company is public if that pertains to you instead.
Client Scenario: Elsa Is Deciding What Equity to Sell During a Liquidity Event
Initial Equity Grant: Elsa joined Company B, a pre-IPO biopharma company, two years ago. Upon joining, she received an ISO grant for 50,000 shares with a $1.90 strike price, vesting over four years.
IPO Delay: While an IPO was initially expected within two years, it has now been delayed to 2027 or later.
Annual Liquidity Events: To retain employees, the company offers annual internal liquidity events.
Additional Equity Grant: Recently, Elsa received an additional NSO grant of 50,000 shares at a $5 strike price. Her husband, Austin, whose company equity has not yielded liquidity, hopes Elsa’s equity will bridge their financial needs.
Given Elsa’s situation, below is a framework and questions to consider to evaluate her options.
1. Should Elsa Sell Existing Shares or Unexercised Options?
Scenario A: Retaining Maximum Holdings
Selling Existing Shares with Qualified Tax Treatment First
If Elsa holds shares that have met the qualified disposition/long-term capital gain requirements (ISO exercised shares held > 1 year and a day post-exercise), selling them first can minimize tax liability versus shares that have yet to qualify.
When choosing which share lots to sell first, you can sell the Highest Cost Basis, Qualified Disposition shares first.
This strategy minimizes the taxable gain difference between the selling price and cost basis, thereby reducing tax liability with higher net proceeds.
Preserve Options with High Upside Potential
Unexercised NSOs will have ordinary income tax implications and automatic withholdings, resulting in lower net proceeds than selling shares.
Unexercised ISOs are the last to sell, given their benefits of exercising and holding through the qualified disposition period.
Scenario B: Planning an Exit Strategy
Sell Unexercised Options Approaching Expiry
If Elsa plans to leave Company B, selling NSOs nearing expiration ensures she doesn’t forfeit value.
NSO exercises add to ordinary income, providing more room to exercise ISOs before hitting the AMT breakeven point.
Choosing Lower or Higher Strike Options and Balancing Liquidity Needs
Elsa will have to make the choice of which options to exercise dependent on her availability of capital and how much she ultimately wants to put into Company B
Lower strike options will have more value and should be prioritized
Negotiating extended option expiration terms before leaving is also recommended!
If Elsa is leaving on good terms and her documents say 90-day expiration after termination, we recommend contacting the company to see if they can be extended further.
ISOs will always only have 90 days to be exercised with their tax-preferred status, but sometimes, a company can extend them further (1-3 years) as NSOs.
2. How Should State Tax Considerations Affect Elsa’s Decisions?
If Elsa is considering moving from a state with high taxes on capital gains to one with no state-level capital gains taxes, timing becomes essential.
Sell or Exercise Options First Before Relocating
Selling unexercised options versus held shares is preferred because, in a state like California, they will still want their cut of the capital gains tax on the income generated from the options since they were originally granted in California.Hold Exercised Shares for Favorable State Treatment
Retaining exercised shares allows her to benefit from the lower or no capital gains tax rate post-move, maximizing post-tax returns.
3. How Should Elsa Address Tender Offer Limits and Family Liquidity Needs?
Company B’s internal liquidity events limit tender offers to 10-15% of total holdings. Elsa and Austin need to determine how much cash they require through 2027 and beyond.
Focus on Bridging Liquidity Gaps
Elsa should calculate how much of her equity to tender to meet short-term family financial needs. Balancing immediate liquidity with preserving future upside is critical.Evaluate Selling NSOs Over ISOs
Selling NSOs first generates ordinary income but leaves ISOs intact, potentially benefiting from long-term capital gains and avoiding AMT triggers.
Contact Us for Tailored Equity Advice
Ready to optimize your equity compensation strategy? Managing your equity sales strategically can lead to significant tax benefits and enhanced portfolio returns. If you’re looking for guidance on how to implement these strategies effectively, our team is ready to help. Contact us today to schedule a consultation.
4 Practical Steps for Equity Sales
Elsa’s decisions demonstrate the importance of tailoring equity management strategies to specific goals and scenarios.
These key principles apply broadly:
Prioritize Tax Efficiency
Focus on selling the least tax-advantaged equities first, such as NSOs and shares with high-cost bases, to minimize tax burdens.Consider Liquidity Events Carefully
Internal liquidity events offer opportunities to secure cash but often come with limitations. Plan sales strategically to align with financial goals.Account for State Taxes and Timing
Relocation and future capital gains rates can significantly impact post-tax proceeds. Plan equity transactions around these factors.Negotiate and Plan Ahead
Before leaving a job, negotiate for extended option terms and plan for exercise costs to preserve maximum value and avoid tax surprises.
What if the Company is Public?
NSOs can be exercised and sold to increase the AMT Breakeven point for additional ISO sales
In some cases, it may be wise to exercise and sell NSO shares to generate capital to pay taxes or exercise more ISO options.
By exercising NSOs, you incur Ordinary Income, which increases the amount of AMT income you can generate from exercising ISO options before actually having to incur an AMT tax.
You will have more flexibility on the timing of the sales
Publicly traded companies offer immediate liquidity, so there is less of a need to bridge liquidity gaps between liquidity events
You will likely not have to worry about tender offer limits post-IPO lockup
IPO lock-up periods generally last anywhere from 90-180 days after the IPO
Maximize Your Equity’s Potential
Elsa’s journey highlights the complexities of managing equity in a dynamic environment. Whether you're balancing current liquidity needs with future growth or navigating tax implications, having a clear strategy tailored to your circumstances is essential.
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Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed.
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Past performance is not indicative of future returns, and investing always carries inherent risks, including the potential loss of principal capital. Any investment strategies are specific to individual clients and may not be representative of the experiences of all clients.
Tax information is provided as a general strategy and is not intended to be tax advice. Please consult your financial adviser and/or tax professional before implementing any strategy.