Post-IPO Employee Equity: Communication is Key

The period leading up to and immediately following an IPO will be a time of great change for any company.

Inevitably, employees will wonder how that change is going to impact them. Depending upon the circumstances, this may fuel a general sense of uncertainty, which, if allowed to fester, could lead to an unhealthy anxiety taking hold in the workplace. This response might be even more pronounced among employee share plan participants, who, particularly in the run-up to an IPO, may be unclear on how going public will affect their equity situation.

The last thing a company will want at any time – let alone in the run-up to going public – is an anxious and unhappy workforce, and the best way to tackle those feelings is to prevent them taking hold in the first place. And how best to go about that? One word – communication.

Communication, employee equity, and IPO

The company may not be able to answer every question, but taking the time to anticipate likely concerns and then providing whatever information they can to offer clarity even before questions are tabled will go a long way towards easing worker anxiety and allowing founders and employees alike to instead focus on the positive possibilities around going public.

As it relates to employee shares, there is no doubt that an IPO can represent an exciting opportunity. That said, several different scenarios may be in play, depending upon the types of equity involved and when and under what terms employees were awarded that equity, i.e., early employees will most likely have been granted options with a much lower strike price than individuals who joined the company closer to the IPO, and will therefore be in a better position to hopefully secure a profit arising from going public. This point underscores the importance of clear communication tailored to individual needs pre-IPO. In other words, it’s not going to be a one-size-fits-all approach. Advice and information that deals with one employee’s situation may not be directly applicable to the circumstances of another, and companies need to be cognizant of that fact when devising their pre-IPO communications strategy.

Employee equity scenarios

Any company looking to craft an effective pre-IPO communications strategy around the implications of going public for employees with equity will need to establish certain key points of information before proceeding.

Among the facts that will need to be considered at the outset are:

• Who has share options and under what terms were they granted?
• Who has been awarded restricted share units (RSUs)?
• What restrictions will apply on selling shares after the IPO?

Once the company has satisfactorily established the key information around points such as those above, it should then be able to anticipate many of the questions that will be asked by equity-holding employees wondering what an IPO will mean for them.

Questions employees will ask about equity and going public

Remember, one of the features of an effective communications strategy in this context will be to offer answers to questions before those questions have even been asked. It is also important to keep in mind that most likely not all employees will be an expert on equity-related matters and may need to ask some basic questions. So, don’t assume everyone has knowledge that they may not possess.

With that in mind, here are some of the questions that you could logically expect employees to ask:

What do I need to do?

As already stated, it’s probably not going to be a one-size-fits-all scenario, so the answer to this question, as with so many others, is “it depends.” But as a general rule, an IPO will have no impact on the status of vested or unvested share options – individuals who hold options will continue to hold them and vesting will continue as scheduled.

So, employees will most likely be under no obligation to act, but that doesn’t mean that they won’t choose to do so, either in the run-up to or at the first opportunity post-IPO. The key point to be teased out here is whether it will be to their advantage to take action. For example, it might make sense to exercise vested options prior to IPO when doing so could lead to beneficial tax treatment down the line.

When should I exercise my share options?

Following on from the point above, the timing of exercising options can have tax implications. To answer this question fully, we need to distinguish between different types of options – incentive share options (ISOs) and non-qualified share options (NSOs).

ISOs qualify for special tax treatment. In practice, this means that no tax becomes due when you exercise your options and then hold them for at least one year. At that point, you can sell and will only be liable for capital gains tax, as opposed to paying ordinary income tax at a higher rate. This means you have a clear incentive to hold on to these shares for at least that one-year period post-exercise.

NSOs are treated less generously. Here, separate tax bills fall due when you exercise your options and then also when you sell your shares. This being the case, more often than not, individuals holding NSOs will look to exercise and sell on the same day.

Relating this to the IPO process, we can see that the answer to the question of when to exercise will depend upon which type of options you hold. With ISOs, a logical approach would be to exercise options pre-IPO and then hope to sell at a profit in the future. For NSOs, if you exercise before the IPO, you may find yourself facing a hefty tax bill, which you may or may not be able to pay. That being the case, the most commonly offered advice with NSOs is to wait until after any post-IPO share sale restrictions expire and then exercise and sell on the same day.

When can I sell some of or all my shares?

Typically, there will be a lockup period of up to six months after a company goes public. Employees will not be able to sell their shares during that period of time.

It is important that all employees with options understand this from the earliest moment, as this period of restriction, will, as outlined above, influence their strategy on when to exercise their options, whether NSOs or ISOs.

I have been awarded RSUs. What does going public mean for me?

RSUs tend to be more straightforward than options, in that you don’t need to grapple with questions around when to exercise them. Whereas when options vest, you then need to decide when or if to purchase them, when RSUs vest, the share units automatically convert into shares and are assigned to the recipient.

Usually, the vesting of RSUs will be linked to time and/or performance conditions, but also to the company going through a liquidity event, e.g., an acquisition, a merger, or an IPO. So, it is entirely possible and perhaps even likely that the vesting of your RSUs will be linked to going public.

This, of course, means that individuals cannot control the timing of the tax event associated with their RSUs vesting. Again, it is important that affected employees understand this and plan accordingly.

Is it a good or bad idea to sell when the lockup period expires?

There is no single answer to this question, but if you highlight a few different scenarios, you will cover many of the possibilities, and at the very least give your employees a sense of where they stand. A general point to highlight here is that the period immediately following the end of the lockup may not be the best time to sell, as if a large number of shareholders look to sell some or all of their shares at the first opportunity, it can have the effect of driving down the share price, at least in the short-term. Against that backdrop, it would not be unreasonable to suggest that individual shareholders who are in a position to adopt a wait-and-see position when the lockup expires should do so.

Summing up

The purpose of this communications exercise is not to answer every possible question or address every imaginable scenario or specific set of individual circumstances; more correctly, the overarching objective should be to pre-empt anxiety, ill-informed gossip, unhelpful speculation, and the damaging uncertainty that can flow from all of that. By putting in place an effective communications strategy you provide useful information where otherwise there might have been a vacuum. Even if you don’t answer every question your employees may have, by getting in front of things and being open, you create a more positive tone than if you adopted an approach more along the lines of simply saying “Contact X if you have any questions.”

Even with the best communications strategy individuals will still have questions, but against the backdrop of having been presented with a detailed FAQ along the lines shown above, your employees will most likely be more informed and therefore better positioned to articulate their concerns. At the very least, people will know the questions to ask, as opposed to wondering what questions they should be asking. At the very least, that is a recipe for lower levels of anxiety!

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