The recent IPO of Klaviyo, a star in the e-commerce marketing space, has sent ripples of excitement throughout the tech startup community. How come? It’s not just because Klaviyo has done so well and gathered a great level of attention along the way (they’re really good at marketing!) Of course, there are other startups doing quite well, in Boston or elsewhere.
It’s also because the IPO market for tech startups has been at a near standstill for almost two years. After a white-hot IPO market in 2021, 2022 brought on large losses for many IPO investors, leading many companies to delay their hopeful IPO listing, and take a defensive stance towards allocating capital during this time.
As a result, many firms started to focus on profitability and conserving cash, so as not to be forced to raise capital in a “down round” (i.e., reduced valuation), or attempt to market their shares to public investors at a time when many peers saw their stock price collapse.
Here's what the highly anticipated IPO of Klaviyo means, for employees who own the stock, as well as the broader tech IPO market.
Implications for Employees with Stock Options and RSU
Among veterans of the startup community, stock options are often seen as a lottery ticket. Essentially, many people perceive that any Incentive Stock Options (ISO) or Non-Qualified Stock Options (NSO) will be worth a life-altering amount of money, or nothing at all.
In most cases, the outcome tends to be somewhere in between.
Often, earlier employees will have ISOs, and these tend to produce the most (potential) financial upside, the greatest level of investment risk, and a great deal of responsibility for if, how, and when they are to be exercised (i.e., purchased) and ultimately sold.
Because these are most common among early employees (and executives, at any point in time), people tend to receive a larger amount of ISOs relative to the amount of any RSUs they may be granted at a later point in time, such as for promotion.
Early on, the exercise price for ISOs can be really low (i.e., $1-5 per share), or in some cases even below $1. From a practical standpoint, what this means is that by the time an IPO listing arrives, almost the entire value of their stock, which can be quite large, is a taxable gain.
The most important factor to keep in mind with stock options (both ISO and NSO) is that exercise alone (without the sale of any shares) can be a taxable event, and therefore it is important to understand the consequences of exercising any options before taking action. Many people underestimate the risk that this presents to liquidity. Specifically, the problem that exercise alone can lead to a large tax bill, without the ability, or desire, to sell shares to cover this expense.
Restricted Stock Units (RSU) tend to be more common among employees who have arrived at a later stage during the growth of the company. For those who arrived early on, subsequent grants are more likely to be RSU than stock options. What’s nice about RSU is that once they vest, they are delivered to employees at no cost, so they always have value unless the price of your company’s stock is zero. Here, the primary responsibility of employees lies with setting aside enough cash for taxes (through withholding, or an estimated tax payment) and, of course, when to sell.
Managing employer stock is about balancing priorities
Whether you’ve received stock options (ISO or NSO), or RSU, your financial life is likely to become a lot more complicated even if, and especially when, your stock performs really well.
Always keep in mind that stock in a tech startup is NOT a stable investment. In fact, that’s the point. This holds true even where the results have been extraordinarily positive.
That’s why it’s important that you consider the three main factors that go into any decision on how you manage your employer stock.
These are liquidity, price, and taxes.
One common trap that people fall into is focusing exclusively on reducing taxes. That’s because most people, rightfully so, view taxes as pain in one of its purest forms, and instinctively, people tend to avoid pain. That’s only rational, right?
Reducing taxes is, of course, important.
The problem of focusing too closely on taxes, however, is that it can lead to unexpected consequences for liquidity, or price, or both.
Most often, this comes up when people decide to hold an investment for at least 12 months, to be taxed long-term capital gains rates, which can be much lower than ordinary income tax rates.
Adverse outcomes like these tend to be most common, and extreme, where a company has seen a meteoric increase in its stock price, and the value of an employee’s stock is multiples of their annual salary. In other words, most IPO success stories.
In cases where such an outcome does occur, it is often because an employee exercised a large amount of stock options, and because they don’t have enough cash on hand to cover taxes, they end up selling stock prematurely to when they had planned, or worse, being forced to do so at a (temporarily) depressed stock price.
That’s why it’s important to focus on liquidity, price, and taxes, without focusing too closely on one at the expense of others.
It’s not uncommon to see plans for selling employer stock change abruptly when a company faces a temporary setback, even while the long-term trajectory remains positive.
Additionally, it’s important not to discount the effects that macroeconomic events which are completely unrelated to the company can have on its stock price.
Resurgence of the IPO Market: What It Signifies
The IPO market has been essentially frozen for nearly two years, due to a combination of IPOs during 2021 being overvalued, and macroeconomic factors (i.e., inflation and rising interest rates) further compounding valuation-related issues.
With so many high-profile IPOs from 2021 seeing huge share price declines without meaningful recovery (many have fallen, and remain, 50-80% below their IPO price), institutional investors who purchase most of the shares sold in IPO listings have stayed away from new deals, for a period of time.
As a result, many firms have raised additional rounds of capital in advance of their IPO, and many employees continue to stare at paper wealth while putting off their own financial goals to a later date.
To resume normal activity, a healthy pipeline of high-profile IPOs is needed, and most of them need to perform well in order build momentum for additional IPO listings.
PREPARING FOR FINANCIAL SUCCESS
The upcoming Klaviyo IPO represents a convergence of long-awaited, significant events within the tech community and financial markets. For employees holding stock options and RSU, this represents compensation that is earned over multiple years but delivered in monetary form over a much shorter amount of time. That’s why we believe the best course of action in handling stock proceeds is a combination of saving, spending, and investing, rather than picking just one, or two.
Here at Paceline, we’re closely familiar with Klaviyo stock options and RSU, and ready to provide any assistance that you need leading up to, and following, your company IPO.
Whether you’ve exercised some, all, or none of your stock options in advance of the IPO, it’s important to update your financial plan and do as much as you can before the end of the year to tee yourself up for success.
If you’ve got questions, or want to learn how we can help, get started by picking a time in the scheduling tool below.
This blog was written by Jeremy Bohne, Principal & Founder of Paceline Wealth Management. Paceline is a fee-only investment advisor serving clients in the Boston area, and on a remote basis throughout the country. Paceline specializes in helping tech and biotech executives, physicians, and those seeking financial planning services.