8 Things to Know about IPOs

Working for a company that is launching an IPO can be an exciting—and confusing—time. As an employee, you might be offered an opportunity to get a stake in your company through stock options or other types of equity compensation. Or you might already own shares in your company and need to know what will happen to your stock after the IPO.

IPOs often bring uncertainty while you wait to see how well your company's stock will perform. It's essential to understand the basics of IPOs before your company goes public and the impact it might have on your financial future.

Ahead, discover answers to some common questions about IPOs, including:

1. What does IPO stand for?
2. What is an IPO?
3. How does an IPO impact employees?
4. What does the IPO price mean?
5. If I have equity in my company, what happens to my shares when the company goes public?
6. What is a lock-up period?
7. What is a blackout period?
8. How will you be taxed on equity compensation tied to an IPO? 

IPO stands for initial public offering. As the name suggests, it signifies the first time a stock is made available to the public on an exchange—like the New York Stock Exchange (NYSE) or Nasdaq—to buy and sell.

An IPO is a way for companies to raise capital from public investors through the issuance of public share ownership. It is the first time a private company lists on a publicly traded exchange and offers its stock to be bought or sold by the public. This is often called "going public."

Typically, a company works with underwriting firms to determine the number of shares to issue and the timeline to launch the IPO. 

When a company goes public, the impact on employees varies. An IPO might not impact you at all or, in some cases, your company might offer you equity compensation. Equity compensation, which can also be provided outside of an IPO, is offered to employees as shares of ownership in the company. It allows employees to share in the success of a company if its stock appreciates in value. Common types of equity compensation include: 

Restricted stock units (RSUs) and restricted stock awards (RSAs) grant you the right to receive a set number of your company's stock shares once they vest, which is the predetermined date when you'll own the shares.

Performance stock units (PSUs) and performance stock awards (PSAs) are similar to RSUs and RSAs, granting you shares when they vest, but the number of shares fluctuate depending on the performance goals set by of your company.

Stock options give you an opportunity to buy shares at a future date for a set price. When the stock options vest, you can exercise your right to buy shares at the set price. There are two main types of stock options: Incentive stock options (ISOs) and non-qualified stock options (NQSOs). 

An ESPP is a program that allows you to buy shares of your company's stock at a discounted price.

When your company goes public, there will be a share price attached to the IPO. This price is the value underwriters place on public shares. 

After the IPO launches into an exchange, its initial price will fluctuate—sometimes significantly. The fluctuations will impact the value of your equity compensation stock.

Before a company goes public, it will inform employees of rules and restrictions related to selling shares owned before the IPO. You may need to wait to sell your shares during a lock-up period or adhere to other restrictions. Consult with your company and review grant agreements and plan packages to understand the details of your plan. 

Many companies enter a lock-up period following the launch of an IPO. During that time, company insiders aren't allowed to sell their company shares. The lock-up period typically lasts between 90 to 180 days.

The lock-up period is designed to stabilize the price of shares after an IPO is launched. It prevents insiders of the company from impacting the value of the stock by flooding the market with their shares. 

In addition to a lock-up period, you might be prevented from selling company stock during post-IPO blackout periods. During blackout periods—which often occur before quarterly or annual earnings releases—some employees are prohibited from trading their company stock or exercising their stock options.

Each type of equity compensation has its own set of tax rules. Here's a general overview of how you will be taxed in the U.S. on some common types of equity compensation. 

If your company grants you RSUs or PSUs, you will experience two taxable events. First, you will pay ordinary income tax when the shares are delivered to you, which is typically when they vest. Then, if you sell your shares, you will incur a capital gain or loss, depending on whether the value of the stock increased or decreased. If you had a gain, you will be subject to capital gains tax.

RSAs and PSAs also let you use the 83(b) election to report the stock award as income in the year shares are granted rather than when they vest. This election allows you to pay all the ordinary income tax upfront, so you won't be taxed again until you sell the shares. You need to make the election within 30 days of the grant. 

With ISOs, the spread (the difference between the award price and the market price) will count as taxable income when calculating the alternative minimum tax (AMT) in the year you exercise your options. If you hold the shares for more than one year past the exercise date and more than two years past the original grant date, the sale of the stock becomes a qualifying disposition, and any realized profit is typically taxed at the long-term capital gains rate. If you sell earlier, the spread will be taxed at your ordinary income tax rate. 

For NQSOs the spread is taxed as ordinary income in the year in which you exercise the options—even when you hold on to the shares—and companies usually withhold some of the proceeds to help pay applicable taxes. 

The tax treatment of your shares typically depends on how long you hold them before selling. For most ESPPs , the sale may be classified as either qualified (sale of shares after one year of the purchase date and after two years of the grant date) or disqualified (sale of shares within one year of the purchase date or within two years of the grant date). This classification will typically determine how much of your gains will be taxed proportionately between ordinary income and capital gains.

Note: These guidelines refers to U.S. taxation. International tax filers may have different obligations. Be sure to meet with a tax professional to discuss your specific situation.