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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Dumping Your Uber Shares? Here are 4 Places to Invest the Proceeds

Sushi chef preparing Uber Eats delivery.

Six months after its initial IPO, Uber’s (NYSE: UBERlockup expiration date is here. Early shareholders and employees of the ride-sharing company are now able to sell their restricted shares. 

If you are selling all or a part of your company equity, you’re probably not feeling too great right now. After reporting weaker than expected bookings on Monday, Uber stock is now down about 40% from its May IPO price of $45 per share. Nonetheless, you’re still due for a nice payday and it’s time to make the most of it. Let’s take a look at some strategies on how to best utilize your investment proceeds. 

Set aside cash for taxes

Both Uber and Lyft (NASDAQ: LYFT) have a double-trigger vesting schedule with its RSU’s. What this means is that your employee shares are not vested until 2 things occur:

  1. A certain amount of time has passed.
  2. A performance event occurs. In this case, the event was the IPO.

When a stock is on a downward trend, the second trigger can have negative tax consequences. Here’s why:

With RSUs, a tax liability occurs when shares are vested and are available to you. Many tech companies offer annual RSU refreshes as an incentive. In most cases, those RSUs are on a phased vesting schedule over multiple years. Therefore, your income is also phased in, not causing a huge bump in any single year. In Uber’s case, most of the RSUs you were granted over the years are vesting at once. As a result, your income will be much higher than normal this year, bumping you up to higher tax brackets.

Here’s more bad news. Uber shareholders are taxed on their IPO price, not the price at the lockup expiration. Instead of being taxed at $27 per share, which is the price it’s going for today, you will be taxed at $45 per share.

Adding fuel to the fire, the federal withholding rate by the employer on RSUs is 22%. Yet because multiple years of RSU’s are all vesting at once, many Uber employees are going to be in the highest tax bracket which is 37%. Someone with $300,000 of RSUs vesting on November 6, will owe $111,000 in federal taxes. However, only $66,000 was withheld by your employer. To make the IRS whole, you’ll need to fork over another $45,000. Underpayment of taxes can also mean you’ll have to pay penalties and interest. To make sure you don’t fork over more than you need to, be sure to consult with your tax or financial advisor before the end of the year.

There’s no telling where Uber shares will be trading come Tax Day. However, you can set aside cash today to avoid a forced sale in the future at potentially lower prices.

Invest in an index fund

The probability of a loss of at least 20% on any one stock over a one-year period is nearly 30%. For a diversified portfolio, it’s 5%. For Uber, the decline has already doubled this level.

Diversification is the single-most-important tool in the investor toolbox to protect wealth. There’s plenty of stories out there about individuals getting rich off one stock. However, Uber may not be that homerun stock. At a market value of nearly $50 billion, the upside on Uber is probably limited. 

With a globally diverse portfolio of index funds, you will likely earn a reasonable return while significantly reducing risk. You can then supplement the index funds with an allocation towards a portfolio of high growth stocks.

Invest in non-tech stocks

Your job is in tech and your home is in an area dependent on tech jobs. Your company stock is in tech and because you understand the industry so well, your stock portfolio is likely tech-heavy too. This could be a recipe for disaster. The Bay Area has historically gone through major tech booms and busts. The ramifications of a technology recession can be painful. Unemployment, loss of equity in your home, and stock market losses are risks you have to plan for.

One strategy to become more diversified is to invest in low-cost index funds such as the S&P 500 but even that index has 30% of its value tied to the Information Technology and Communications sectors. To achieve true diversification, you have to look at the sectors of the funds and/or stocks you invest in.

Don’t get me wrong. I love technology as an investment. I believe the era we live in today is the technological equivalent of the industrial revolution in the late 1700s. 

However, one should be careful not to have too much of your net worth dependent on a volatile sector.

High-yield online savings account

Are you looking to sock some of your hard-earned money away to buy a home or send your high schooler to college? While the safety of cash is important, there’s little reason to keep your money in a standard checking account. 

While the big banks are paying 0.06% or less on savings account, FDIC insured online banks are paying about 2%. Over a five-year time period, the interest earned in an online savings account could be nearly 5 times that of a big bank. 

A favorite tool of mine to research the latest rates across the country is from Bankrate. Be sure to read the fine print. Many banks offer a teaser rate which drops significantly after the promotional period.

Municipal bonds

While an online savings account is better than cash under your mattress, the interest earned may barely be enough to keep up with inflation. For those in a tax bracket with a willingness to take a small amount of risk, municipal bonds may make sense.

Municipal bonds are issued by states, municipalities, and counties to finance capital expenditures such as schools, bridges, high-speed trains, and infrastructure. If you purchase the municipal bond of the state you live in, the income earned from those bonds may be exempt from federal and state taxes. 

The after-tax earnings from a municipal bond can be quite large. Below are the pre and post-tax yields for someone in the 37% federal and 10.3% state tax brackets.

 Pre-tax equivalent yieldAfter-tax yield
California municipal bond4.74%2.5%
High-yield savings2.0%1.05%
Big bank savings0.5%A waste of time

Of course, there’s no free lunch. Albeit small, there is some downside risk, especially if California goes through a liquidity crisis.

As a proxy, during the financial crisis in 2008, the Barclay’s California Municipal Bond Index had a total return of -4.16%. Assuming this is a worst-case scenario, the value at risk on a $100,000 portfolio is about $4,000. 

So, are muni bonds right for you? You have to ask yourself if the potential of earning 2.5% after-taxes is worth the downside of 4%.

Speak with a financial advisor that understands you

Lockup expiration day is an exciting time for Uber employees. It’s the payoff for the long hours put in from the startup phase. For those who are cashing out, the payoff doesn’t have to stop. By making a few smart moves, you can reduce risk and get even closer to achieving long-term wealth that can be passed down to generations to come.

If you are an Uber employee or an employee of a company where equity compensation is a large part of your income, you should speak with an advisor that understands your situation. You can schedule a no-obligation consultation with me here. The initial meeting is free. So is the second meeting where Before you pay me a single dollar, I will present to you a plan that shows exactly how I can help. 

No worries if you aren’t ready to talk. You can sign up for my e-newsletter which includes easy to understand financial planning articles to help you make good decisions with your money.