On a day-to-day basis, running your startup involves tasks like writing employment offer letters or deciding how to compensate startup interns. In the long run, however, you’ll need to keep an eye on your company’s exit strategy. Here, the two main options are either to sell a startup in an M&A transaction, or to take the company public in an IPO (initial public offering). During an IPO, a privately owned corporation becomes publicly traded, allowing members of the public to purchase shares. IPOs are also an opportunity for the startup’s employees to exercise stock options that they were offered when joining the company. Stock options are the most common way that startups compensate employees without paychecks. Recent years have seen a massive increase in the number of IPOs. In 2020, there were 494 IPOs in the U.S. market, setting a new record and more than doubling the number from 2019. The trend attained new heights again in 2021, with more than 1,000 IPOs in the U.S. stock market. But what can startup employees expect when their company goes public? If you’re contemplating “How much do employees make from IPOs?” or “What does an IPO mean for employees?”, keep reading for the answers.
Do employees make money in an IPO?
With a high enough share price, a startup’s employees could become a lot richer by selling their stocks. This is especially true for employees who joined in the company’s early stages, and who usually own a larger percentage of the business. But if one IPO could make workers wealthy, another could be a major disappointment. In March 2021, for example, the IPO of the food delivery app Deliveroo was called “the worst IPO in London’s history” when the company’s stock price plunged by 26 percent in one day. The factors that tend to make an IPO successful include a large market of potential customers, a unique value proposition, intriguing products and services, and strong cash flow and revenue. However, even the most promising startup IPO can be impaired by external factors such as market conditions, the performance of competitors, and too much media hype.
What happens to employees in an IPO?
In an IPO, employees have the option to hold or sell the company shares they own. However, employees and other company insiders (e.g. founders and inventors) who want to sell shares generally need to wait until the end of the “lockup period,” which typically lasts from 90 to 180 days.
More specifically, employees have the option to purchase company stock at a specified price per share, known as the “strike price.” This amount is set at the time the employee receives the stock option (e.g. when joining the company). If the company’s stock price has risen above the strike price, employees can then sell their stock at a profit. One important question is when employees should exercise their stock options for the most favorable tax treatments. According to Wealthfront, the ideal time is at least one year before the company’s planned IPO date. Doing so will qualify you for the lower long-term capital gains tax rate, instead of the higher ordinary income tax rates. To qualify, however, you’ll need to have held your exercised shares for at least one year. In addition, the stock options must have been granted at least two years before the date you exercised them. You also need to weigh the potential tax savings against the possibility that you could earn more by exercising at a different time. Even before an IPO, there are ways for employees to trade their company stock. For example, Nasdaq Private Market is a platform that lets investors purchase pre-IPO shares. This concept is known as a “tender offer,” in which private buyers can invest in the company before it goes public.
How much do people make on an IPO?
In a HackerNews thread titled “How much did you make from your IPO?”, a few startup employees shared their experiences when their companies went public. Although the stories here are anecdotal and may not be representative, they still help provide a clearer picture of how much employees can expect to make from an IPO:
- Employee #1: One of the first 5 employees at a Y Combinator “unicorn” (i.e. a startup with a valuation over $1 billion). The initial job offer was for 0.5 percent of the company’s shares, although the employee departed the company before all of these shares vested. According to the employee, the shares are worth $1.5 million pre-IPO, with an estimated value of $3 million to $5 million post-IPO. While at the company, the employee lived in San Francisco and had an annual salary of $120,000.
- Employee #2: One of the first 30 employees at a startup with a valuation over $1 billion. The employee received $700,000 (post-taxes) after the company’s IPO, and expects to earn another $1.2 million in grants and restricted stock units (RSUs) over the next several years. The employee’s starting salary at the company was $70,000 as a mid-level developer, and is now $190,000.
- Employee #3: The 13th employee at a startup with a valuation over $1 billion. The employee accepted a junior non-technical role, with a four-year vesting schedule worth $1.05 million. After leaving the company, the employee accepted a tender offer to purchase some of the employee’s stock.
Of course, these employees were all fortunate enough to work for “unicorns” with very high valuations, making these stories atypical. Most startup employees will see far less money when their company goes public. However, by working hard and choosing the right employer (along with a bit of luck), there’s no reason that workers can’t enjoy a successful IPO.
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