If the company you own or work for is being taken public through an IPO or being acquired, it’s important to fully consider how to manage the large concentrated stock position in your investment portfolio that may result.
Such a concentrated position can leave your investment’s performance exposed ― not only to the upside benefits of either the newly listed company or new parent company but also the downside risk and vagaries of the market in general.
As a result, carefully plan how to either liquidate your position or help reduce the risks associated with holding on to your concentrated position.
Liquidating your holding and repositioning your portfolio
The capital gains taxes due on the sale of your stock will be an important consideration as you decide whether to keep or liquidate your holding.
The amount of capital gains taxes you may have to pay will depend on how long you’ve owned the stock and the cost of that stock when it was awarded to you (its cost basis) versus its price post IPO or acquisition.
For stock you’ve held for less than 12 months, capital gains are taxed at your marginal income tax rate. The top income tax rate is currently 39.6% (as of 8/1/17). For stock held more than 12 months, long-term capital gains are taxed at 15% or 20%. Both long- and short-term capital gains are subject to an additional 3.8% surcharge on unearned income.
Gradual sales over a period of time may be an alternative to selling all at once, helping to spread potential gains and any resulting tax over a number of years.
Capital gains in any one tax year can be offset by unused capital losses carried forward from previous tax years, as well as by any capital losses realized in the year of sale.
Due to your role in the now-public company and access to nonpublic information, you may experience challenges in selling your stock. 10b5-1 plans offer a way for corporate executives to sell stock based on a pre-planned trading schedule to demonstrate that inside information was not a factor in the sale.
The plans can be customized from the outset to meet varying objectives. Once the plan is in place, however, there are limitations to the changes you can make. You may want to consider retaining your concentrated position and managing the risk of retention.
Managing the risk of retention
A number of strategies will allow you to monetize (provide liquidity) the risk of holding your concentrated position.
- Hedging strategies can be used to moderate the impact of a concentrated position’s volatility. Such strategies may involve using derivatives such as puts, calls, and collars. A derivative itself is a contract between two or more parties. The value of a derivative is determined by fluctuations in the underlying asset, in this case the stock included in your concentrated position.
- Diversification strategies will allow you broader market participation without forcing you to liquidate your concentrated position. Diversification strategies include:
- Margin loans
- Exchange funds
- Derivative strategies such as variable prepaid forwards
- Hedging strategies combined with loans
Many companies have restrictions in their trading policies preventing certain individuals, such as corporate insiders and executives, from entering into derivatives contracts. Thus, many executives will be precluded from hedging or pledging by using strategies such as puts, calls, and collars.
Always consult with your company’s compliance officer or corporate counsel on your organization’s trading policies.
Strategic planning is key
The IPO or acquisition of your company may be the most important financial event in your life. But helping maximize the potential long-term financial rewards of the liquidity event requires strategic planning.
We highly recommend working with your advisory team (tax accountant, financial professional, financial planner, estate attorney, and your company counsel) to help put a financial plan together prior to your liquidity event.
There is no “one size fits all” solution; the best solution will likely not be a single strategy but a combination of several strategies customized for your unique situation.
The strategies listed are not suitable for all investors, and there can be a high degree of risk with exposure to potentially significant loss.
Because of the importance of tax considerations to all options and stock transactions, consult with your tax advisor to evaluate how taxes can affect the outcome of contemplated options and stock transactions.
Congratulations on your company’s IPO or acquisition!
Additional information is available upon request.
Investment and Insurance Products: Not FDIC Insured. No Bank Guarantee. May Lose Value.
The information in this report is for educational purposes only and should not be used or construed as financial advice or a recommendation to participate any strategy mentioned herein. Wells Fargo does not guarantee that the information supplied is complete, undertake to advise you of any change in its opinion, or make any guarantees of future results obtained from its use. The concepts discussed in the paper require the assistance of qualified legal counsel and tax advisors and investors should consult their own attorneys and tax advisors with respect to their own situations.
Wells Fargo Private Bank provides products and services through Wells Fargo Bank, N.A. and its various affiliates and subsidiaries.
Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.
Wells Fargo & Company and its affiliates do not provide legal advice. Please consult your legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared.
Because of the short-term nature of options, it is likely that they will be traded more frequently than stocks and bonds. With each option-related trade, a commission will be incurred. Commissions on option transactions generally amount to a higher percentage of the principal than commissions for normal stock trades.
Trading in options can result in losing the total amount of premiums and commissions paid. Additionally, when covered call options are sold, the underlying securities must be delivered at the strike price upon exercise of the option.
Additional information is available upon request.
©2018 Wells Fargo Bank, N.A. All rights reserved. Member FDIC.