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: UBER) lockup 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.

Perspective, Gratitude, and Feeding the Bear

Well, it looks like some normalcy has returned to the markets. After 18 months of steady stock market gains in one of the lowest periods of market volatility in history, we are starting to experience some discomfort. The financial media has been their typical self and have done a good job of reporting just how normal (sarcasm) the downward swings are. Here are some actual headlines over the past week:

  • Dow Experiences Biggest Point Drop in History
  • S&P 500, Dow Suffer Biggest Weekly Decline in More than 2 Years
  • The Dow Jones Industrial Average Crash Raises One Question: Is the World Ending?
  • Market on course for 6% drop, biggest one-week fall since 2008

I don’t want to discount the downturn. Yes, the 1,100-point drop in the Dow on Monday was the largest in history. However, on a percentage basis, which is what investors should be looking at, it was the 538th largest decline in history. This of course, doesn’t make a for a good story. If I was a headline writer, here is what I would have written (and subsequently receive zero clicks, leading to a prompt termination):

  • Dow Experiences 25th Worst Loss since 1960
  • S&P 500 Declines to Levels Not Seen Since November 20th – Yes, 2.5 Months Ago
  • The World Fails to End…Again
  • Market Drops 6% in One Week after Increasing 234% over 9 Years

What happened in the markets over the last week can be scary but it’s also normal. The S&P 500 and Dow has officially reached “correction” level which is defined as a 10% downward movement from peak to trough. A drop of this magnitude in such a short period of time should not be discounted. However, it also need to be into perspective. This is the 91st time a 10% correction has occurred since 1928. If stocks fall another 10%, which is entirely possible, it wouldn’t be outside of the norm either. A 20% drop, officially a bear market, would be the 22nd since 1928.

 

No panic here

One lesson I learned over the past week is that I have the best group of clients an advisor can ask for. Although small in terms of quantity, they are robust in composure. A parent at my child’s school said to me yesterday, “Man…your phone must be overheating.”

 

Nope.

 

Quite the opposite actually. I didn’t receive one phone call, text, or e-mail. My clients were not worried. Nor were they surprised. In fact, they frankly didn’t care. Instead of worrying about markets they can’t control, they were busy controlling what they could — yelling at their kids, enjoying the perfectly normal February sunshine, and debating what wine to drink with barbeque (Syrah…or better yet, beer). It was the same attitude I had which tells me that I’m blessed to be in a bunch of perfect marriages.

The biggest investing mistakes usually made are emotional, all-or-nothing decisions when the market is in free-fall. A necessary part of a good advisors where he or she adds the most amount of value is talking their clients off the ledge. While I’m prepared to have this conversation, given the strong bull market, I haven’t had to. This was my first opportunity and it hasn’t been necessary. In fact, a strong stomach from my clients opens up the door to some tremendous opportunity –taking advantage of a downturn.

 

Strategy to feed the bear

“We’re rich because we were smart when others were dumb” – Charlie Munger, Vice Chairman of Berkshire Hathaway

 

The above isn’t an exact quote. I’m paraphrasing something I heard Warren Buffet’s partner say during one of Berkshire Hathaway’s annual meetings. Nonetheless, his point is valid — the best time to buy stocks is during times of panic.

 

However, this is easier said than done. Buying low makes complete sense and every investor can’t wait to do just that. The reality is that when asset prices fall they become sellers rather than buyers.

 

A 10% drop from arguably extended valuation levels is not exactly a buying opportunity of a lifetime. That likely occurred in 2008 and 2009 and it’s a market we likely won’t see again during our lifetime. However, today is a better buying point then last week, and the odds that the market will be higher 5 years from now has increased.

 

According to research from financial columnist Morgan Housel, after a 10% drop from its peak, stocks are higher in five years 86% of the time. The average return during those five years is 51%. After a 20% drop, those numbers increase to 89% and 61% respectively. Logically, the larger the drop, the higher future returns will be. And there’s a higher probability of achieving those higher returns. That’s not a bad deal.

Five years from now, the markets most likely will have made some gains
Source: The Motley Fool

 

While logic states you should deploy your cash now, the fear of regret is going to overpower logic. Here are some perfectly normal thoughts you may be having right now:

 

What if the market drops even further? It’s too early to start buying.

This feels a lot like 2000 and 2008. What if we have another crash? I don’t want to feel that pain again.

This time, I’m going to be aggressive when others panic.

 

The market may continue to fall. It might not. If you invest your reserves now and it falls further, you’ll be kicking yourself. If it doesn’t, and you don’t buy, you’ll be kicking yourself.

 

To be a successful investor, you don’t need to time the markets. You need to control your behavior. Therefore, you need a strategy that’s rule-based, taking the emotion out of your investing decision. Let’s say you have $10,000 in dry powder that you are ready to invest during a downturn. Instead of investing it all in one chunk or waiting too long, a rules-based strategy on deploying a set amount at various drawdowns is a sound strategy. The approach I’m going to show you is adopted from Morgan Housel who articulates it much better than I in this article. Here is a summary:

 

Market falls You invest… Historical Frequency
10% $1,000 About once a year
15% $2,000 Every 2 years
20% $3,000 Every 4 years
30% $2,000 Every decade
40% $1,000 Few times in an investing lifetime
50% $1,000 Once in an investing lifetime

 

With the strategy above, more than half your available funds will be invested after a 20% decline. Larger declines are rarer, so it makes sense to invest sooner rather than later. However, in the event that the market continues its descent, you’ll still be able to take advantage of lower prices.

 

Significant wealth can be created during bear markets which fortunately, yes fortunately, also occur pretty regularly. We haven’t had a 20% decline since 2009, twice as long as the average frequency. While not predictable, it shouldn’t be surprising if such a drawdown occurs again.

 

Whether this strategy is followed with the precision of an olympian archer is not important. What is important is prepared and having a strategy. A simple plan will alleviate mental stress which in turn, leads to less hasty decisions and ultimately, better returns.

Allow me to help you create a portfolio built for a bull or bear market. Get started today by clicking the link below for a FREE portfolio review.

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2 Things Other Advisors Will Disagree With Me On

“What’s your philosophy?”

This question has frequently popped up in my first year as a Financial Advisor. It’s a good and fair question, albeit a loaded one. When I hear that question, I believe most people are referring to investing. If so, the answer is not sexy or surprising – it’s long-term, buy and hold. However, good financial advising is about more than just investing. Real financial advisors look at a client’s entire picture. They take debt, college planning, real estate, insurance, and estate planning into account. However, even here, the answers across planners are pretty standard:

  • Save more than you spend
  • Pay higher interest debt first
  • Invest in a 529 plan
  • Term life insurance is usually better than whole life
  • Have a will and a living trust

Nothing shocking. Execution is often more difficult than the theory but it’s pretty straightforward. Now, you may be asking, “what makes you so special?”

For one — I’m tall, brown, and handsome. Hopefully, that’s enough to gain your confidence but if not, I do have a couple financial philosophies that differ from most advisors.

 

Enjoy your latte and avocado toast

There’s a recent article in Money Magazine titled, Millionaire to Millennials: Stop Buying Avocado Toast If You Want to Buy a Home.

I mean…really? In that article, an Australian property mogul insinuated that folks shouldn’t eat out so much or buy a $4 cup of coffee if they want to afford a house. Well, doing some quick back of the envelope math, sacrificing a latte a day would mean that you would have enough to afford a down payment in San Francisco by May of 2195. That’s 65,000 lattes.

The Money Magazine article reminded me of a story I once heard from Morgan Housel, a Loeb Award finalist for financial journalism. It’s about a guy taking a smoke break with his non-smoking colleague.

“How long have you been smoking for?” the colleague asks.

“Thirty years,” says the smoker.

“Thirty years!” marvels the co-worker. “That costs so much money. At a pack a day, you’re spending $1,900 a year. Had you instead invested that money at an 8% return for the last 30 years, you’d have $250,000 in the bank today. That’s enough to buy a Ferrari.”

The smoker looked puzzled. “Do you smoke?” he asked his co-worker.

“No.”

“So where is your Ferrari?

If you don’t smoke you can substitute coffee for cigarettes and work through similar math. It’s the type of math many advisors use when speaking to colleagues about saving every last buck and letting the magic of compounding interest do its work. However, it doesn’t take into account the simple joys in life. Sure, not buying a pack of cigarettes or a Starbucks a day will save you money. But it may not save you from strangling your boss. Within reason, vices can be good for people; there’s an upside to happiness.

The goal of financial advising should not be to put a stop to happiness but to help you find ways to achieve the life you want. That probably involves a few vices or experiences that just feel good.

 

The market can be beat

Studies have shown that over a 10 year period, more than 85% of fund managers failed to perform better than the S&P 500. These statistics have led many advisors and those in academia to conclude that the market cannot be beaten.

I don’t buy into what academia attempts to preach. Imagine if a medical student was told that no matter how hard they try; they will just be a mediocre doctor. Investing and portfolio management is probably the only subject matter where professors will tell their students that it’s impossible to be better than average.

All the statistics tell me is that mutual fund managers cannot beat the market. I believe individual investors can.

Mutual funds have a tougher battle than individual investors. Fund companies have to hire portfolio managers, research analysts, compliance folks, sales teams, and accountants. These people cost money and they are paid through the contributions from investors, therefore hindering investment returns.

There is also unbelievable pressure for those funds to outperform the market on an annual or even quarterly basis. Therefore, stocks are being bought and sold frequently, not giving a sound investment idea time to perform. Fund managers also face pressure from their bosses to go with the herd. A couple years ago, every manager was all-in on Apple stock. However, when signs of slowing growth started to emerge at Apple, the stock declined nearly 30% from its highs. Many of the funds that were overweight in Apple struggled. However, those managers weren’t going to lose their jobs because, “hey, it’s not my fault — everyone was invested in Apple.” Had the stock gone up 30% and a manager was not invested in the popular company, they may be on the hot seat. Of course, Apple recovered but the point is that it’s tough for fund managers to go against the grain. As an individual investor, you do not face that same pressure.

You as an individual investor can avoid Wall Street’s outrageous fees and short-term pressures. Your edge is that you have the advantage of time. Your investments don’t have to be better than the competition every year or quarter. You can own great companies and give them time to run.

Now, don’t get me wrong. I’m not saying that beating the market is what you should be trying to do. As an individual investor, you should try to do well enough to achieve certain goals such as retirement or paying for your children’s college education. This can often be done by just investing in a diversified mix of low-cost index funds. This alone will likely lead to better returns than 85% of mutual funds. However, investing in high-quality individual stocks alongside those index funds can be a great way to enhance returns.

Is your 401k optimized to help you meet your retirement goals? Are you paying too much in fees for under-performing funds in your retirement plan? A 14-year Vanguard study showed a good financial advisor can add up to a 3% value to its client — a difference of $500,000 for someone maximizing their 401k over 20 years. Click below to schedule an appointment for a FREE 401k evaluation. 

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