An initial public offering (IPO) represents the culmination of years of work to build a startup enterprise into a publicly-traded corporation. Young companies just starting out do not typically have access to large amounts of capital. To conserve cash and attract bright, experienced employees, businesses often issue stock options that can provide a windfall to recipients when the company goes public.
Liquidity
Options acquired prior to an IPO are often difficult to value properly and thus exercise. Once the company becomes public, however, the options are typically traded on one of the major exchanges (such as the Chicago Board Options Exchange), which provide access to many buyers and sellers as well as up-to-the-minute quotes. While other requirements may be in force depending on individual business circumstances and contracts, the IPO generally provides the means to accurately value and sell employee options.
Vesting Schedule
The vesting process is usually spread out over a number of years, but can also happen if key performance milestones are met. Once this occurs, holders are permitted to sell their stock or options without penalty even if they leave the company. Beforehand, however, employees risk forfeiting options, which can amount to a significant asset after the company becomes public. This golden handcuff is highly effective at keeping employees within the fold as the company grows and prepares for its public trading debut.
Post-IPO Requirements
The original options agreement, generally negotiated at the time of hire but subject to revision upon mutual consent, can contain restrictions on when the options may be converted to common stock and sold after the IPO. Also, the Securities and Exchange Commission has rules in play that prescribe when employees may sell their holdings, which may happen in large numbers in the days after eligibility and cause a price decline, which is often temporary.
Options Exercise
As a practical matter, holders of stock options may not have the cash on hand to acquire the underlying stock, in which case they can borrow the money from the company or work with a brokerage to complete the transaction. The tax implications of any such transaction must be considered, and the decision whether to hold onto some or all of the shares may be influenced by how much is owed to the government.
