How Employees of High-Growth Companies Should Be Thinking About Company Equity

Fastly CEO Artur Bergman and team ring the bell at the NYSE.

Fresh off the heels of Uber Technologies Inc (NYSE: UBER) lockup expiration period last week, another San Francisco based tech company will go through the same on November 13. Fastly, Inc (NASDAQ: FSLY) isn’t a household name like the ride-sharing behemoth. 

Fastly is a content delivery network (CDN). By bringing servers and data centers closer to the end customer, it can provide the end user with a faster, safer internet experience. The CDN business is extremely competitive and investors seem to not know what to make of it. Just four months after its IPO of $16 in May 2019, the stock more than doubled to about $34 per share. A day before it’s lockup expiration day, Fastly is trading for $19 per share.

The volatility of IPO can be tough to stomach but the upside potential is appealing, especially for employees and early investors. There also comes risk. For example, six months removed from its IPO and fresh off its lockup expiration, shares of Uber stock are down 40% from its IPO price.

But six months does not make an investment career. For long-term investors, volatility is the price of admission and should be an after-thought when it comes to obtaining long-term wealth. 

Deciding whether to hold or sell company equity shouldn’t be based on short-term price fluctuations but on financial goals, concentration risk, and company prospects. Let’s take a look at what employees of Uber, Fastly, and other soon-to-IPO companies should think about when deciding what to do when their shares become free.

Swinging for the fences

Outsized returns often come from betting against conventional wisdom, and conventional wisdom is usually right. Given a ten percent chance of a 100 times payoff, you should take that bet every time. But you’re still going to be wrong nine times out of ten. 

We all know that if you swing for the fences, you’re going to strike out a lot, but you’re also going to hit some home runs. The difference between baseball and business, however, is that baseball has a truncated outcome distribution. When you swing, no matter how well you connect with the ball, the most runs you can get is four. In business, every once in a while, when you step up to the plate, you can score 1,000 runs. This long-tailed distribution of returns is why it’s important to be bold. Big winners pay for so many experiments.

 – Jeff Bezos, 2016 Amazon shareholder letter

Conventional wisdom will tell you to diversify your portfolio. But a part of the intrigue of working at a young tech company is the potential for striking it big. While diversification can preserve wealth, concentration can create it. And create it fast. However, you still have to be smart about risk management.

When it comes to deciding how to divide a cash and investment portfolio, I like to think in terms of building assets into three buckets:

  1. Protective assets – cover necessities and short-term needs such as your home, emergency reserves, medical care, home improvements, and family vacations. Allocate cash to this bucket.
  2. Market assets – covers basic retirement goals, second homes, and college funding. Use a diversified portfolio of stocks, bonds, and real estate for this bucket.
  3. Aspiration assets – buying a dream home on the beach, early retirement, creating generational wealth, leaving a legacy, buying an NBA team, or having your own private jet. This can be your concentrated and high-risk bucket.

Once you know how much to protect and how much you need to put away to cover your basic goals and needs, you can figure out how much to allocate to company stock. 

Know your risks

While the upside of any single position is much higher than a diversified portfolio, the downside is much larger too. A negative corporate event such as bankruptcy, loss of a key person, or criminal activity can lead to permanent losses (remember Enron). With a company like Fastly, which is not a necessary monopoly like PG&E, investors shouldn’t expect a bailout from a negative event such as an unrecoverable security breach. WeWork is a prime example of a company that went from Wall Street darling to pulling out of its IPO, to nearly having to shut its doors. 

While you can swing for the fences, your decision doesn’t have to be all or nothing. And when you do, you don’t necessarily have to think about how your life will be affected if the stock went to zero. Bankruptcies are common but the probability is low. However, you should think about what may happen with a loss of 70%+, especially when it involves a volatile tech company.

Know your biases

Money is emotional. There’s no denying that. Naturally, money decisions are often not based on logic and the best long-term outcome. Knowing your biases will help you overcome or mitigate those emotions. 

Here are some of the common behavioral biases that apply to equity compensation:

  • Overconfidence and familiarity: employees feel that because they work for the company, know the management team, and understand the business, their stock will also do well. They’ll also believe they’ll be the first to know if things are getting worse. The market is very smart. Unfortunately, familiarity and confidence don’t lead to better stock market returns. 
  • Status quo bias: it’s easier to do nothing rather than making a change. This leads to overconcentrated portfolios with outsized risk.
  • Regret avoidance: If the stock goes up, I’ll miss out on my payday and will be kicking myself for the rest of my life.
  • Loyalty effects: the desire to be loyal to your employer or not be seen in a negative light in front of your peers. If you feel this way, keep in mind that your company has an exit plan. You should too.
  • Price anchoring: the stock was worth double a year ago. I’m down 50% and want to gain my money back before I sell.

If you are a victim of any of the above biases, don’t be ashamed. It’s normal. But simply being aware of those emotions doesn’t always lead to an optional outcome. Asking yourself this question might:

“If I received X dollars in cash (amount of equity compensation you have), how would I invest this money?” 

Is your answer going to be 100% in the company you work for? If not, you should consider selling stock when the rules allow for it.

One more important consideration

I’ll dig deeper into this in a later article, but your company’s prospects play a large part in deciding what to do with your company stock. My favorite investor, David Gardner of The Motley Fool, likes to use the finger snap test when deciding if a stock is worth holding. If you snapped your fingers today and the company went away, would people and/or business be disrupted in a negative manner? Is there an alternative? Would that company be missed? 

This isn’t the only criteria. The strength of the management team, company culture, growth in revenue and cash flow, and the strength of its balance sheet also plays a part. In Fastly’s case, founder CEO Artur Bergman owns over 10% of the company. Margins are slowly increasing, and it’s winning some big customers – both signs of a better mousetrap. It’s losing money but it’s growing revenue over 30% year over year.

These are a few of the positives that led me to take a position in Fastly for my personal portfolio along with some of my risk-seeking clients. I expect volatility, especially after the lockup expiration date. However, we are diversified enough that we won’t be looking to take on a side hustle in the circus if the stock goes south. 

Be sure to do the same when deciding what to do with your company stock. 

Disclaimer: Palbir Nijjar and some of his clients own Fastly stock. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services.

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Breaking the 2-Hour Marathon-Distance Barrier

Kipchoge hugging his family

Early in the morning of a misty October day in Vienna, Eliud Kipchoge of Kenya ran the marathon distance in less than two hours. His time, 1:59:40, is the fastest time that any human has ever covered 26.2 miles, becoming the first runner to ever break the two-hour barrier.

In becoming the first to ever cover the marathon distance in less than two hours, Kipchoge achieved a milestone once-considered impossible to achieve, akin to when Roger Bannister became the first person to break the 4-minute mile in 1954, with a time of 3 minutes and 59.4 seconds.

Critics are quick to point out that Kipchoge, an eight-time major marathon winner and three-time Olympic medalist, did not run under “open marathon” conditions and as such, his feat should not be recognized as an official world record.

But no matter the critics, the accomplishment was one that required an incredible amount of planning and skill, and one that all investors can learn from. Let’s explore.

Kipchoge Had a Very Specific Goal

Kipchoge owns the two fastest times in sanctioned marathons when he posted world-record times of 2:01:39 in Berlin in 2018 and 2:02:37 in London. But he had another goal for his race in Vienna. And it was not to just run a sub-2-hour marathon.

Kipchoge’s goal was to cover the 26.2 miles in exactly 1:59:50. He beat his time by 10 seconds.

Also, Kipchoge added a perspective that further fueled his very specific time goal when he said:

“Berlin was about running a world record. Vienna is about running and breaking history, like the first man on the moon.”

As an investor, how precise are your goals? And remember, saying something along the lines of “I want to retire with more money” is not a goal. It needs to be specific and measurable.

Kipchoge Had a Team Working for Him

Kipchoge did not run alone. In fact, he had one of the most advanced teams a runner could hope for. In addition to corporate support from INEOS, one of the world’s largest chemical producers as well as sports-giant Nike, Kipchoge had a running team designed specifically to help him achieve his goal:

  • He ran behind an electric timing car driving exactly at the speed of 4 minutes and 34 seconds per mile, with a backup car on standby just in case.
  • He had 35 pacesetters with six on reserve and these pacesetters were among the best in the world, including former world and Olympic gold medalists Bernard Lagat and Matthew Centrowitz.
  • He had nutritionists who fed him gels and fluids that were developed specifically for him and delivered at just the right times so his performance could be optimized.

Most importantly, Kipchoge’s pacemakers formed a protective, aerodynamic wedge around him, with five of the pacemakers running in front and two more in the back. These seven pacemakers would be replaced by a new group of seven with fresh legs. Further, they knew exactly where to run thanks to green laser beams projected onto the street by the timing car.

Investors need teams working on their behalf and working specifically toward their goals too. In addition to the need for a financial planner, investors often need a team of experts, including money managers, tax experts, lawyers, and accountants.

Kipchoge Picked the Best Course

Kipchoge just didn’t pick any course to run, he picked a location and course that would be best for him to achieve his goal. He and his team settled on Vienna due to its Goldilocks environment. It wasn’t too hot, too cold or too hilly.

Kipchoge ran a course that was 90% straight with portions of the road painted with lines to highlight the fastest possible path. He didn’t need to think about the running-technique called “running the tangents” at all. He followed the line.

Similar to how investors need to “follow the plan.”

Kipchoge Had a Good Day

Every investor knows that some days are better than others, as are some months and some years. And while we might not ever know for sure, Kipchoge would likely have tried again had he failed. But he didn’t fail.

Long-term investors should heed the words of Jim Ratcliffe, the founder of INEOS, when he told Kipchoge:

“There are no guarantees in sports. You could have had a bad day. But you had a really good day.”

Kipchoge Had the Support of His Family

In a scene that will be replayed millions of times on YouTube, Kipchoge crossed the finish line and excitedly jumped into the arms of his family.

But what most don’t know is that despite all the years of running, all the wins, all the medals, and all the world-records, this was the first time his family had watched him run in person.

Without question, Kipchoge’s family has sacrificed over the years and it was only fitting that they could share the world-stage as a family. And their celebration highlights the importance of planning as a family and celebrating as a family. Because financial planning will require goal-setting and decisions that are best made together.

Kipchoge Had a Dedicated Coach

Most of the stories covering Kipchoge’s incredible feat will pay little attention to an important detail – the fact that Kipchoge had a coach.

Patrick Sang is Kipchoge’s 55-year old, long-time running coach and was also an accomplished runner himself. He ran in college at the University of Texas and won a silver medal at the 1992 Summer Olympics. He does not seek attention or accolades, but he’s very driven to help his athletes achieve their goals and dreams.

Kipchoge summed up the importance of his coach perfectly when he said of Sang:

“He has taught me the morals of life, how to really concentrate and be happy and not go off course. He’s a mentor, a sports coach, and my life coach.”

It sounds a lot like the hallmarks of a great financial planner.