Create A “No Regrets” Selling Plan For Your Stock Comp

At 30-40 Wealth, one of the strategic activities we frequently work with our clients on is developing a selling plan for a concentrated position they own (e.g. options and stock holdings in a publicly-traded company). Balancing downside risk, upside reward, individual financial needs/requirements, and optimizing for tax when developing a selling plan isn’t easy — but it’s well worth it. And since you’re reading this article about creating a selling plan for stock comp, my guess is one of the below situations rings true for you:

• Your company recently went public OR you've held onto some of your vested RSUs over the last few years, and now have a big concentrated position

• You want to start divesting (or at least you know you should be), but don’t know how you should go about doing it and don’t want to make a mistake

If that sounds familiar, you're in the right spot. We've helped a lot of individuals navigate this dynamic. Every situation is nuanced, but the framework of the approach we utilize is below.

3 Key Items To Consider Before Developing a Selling Plan

Before we dive into the details of how to create robust selling plans, our experience has found that it's best to first highlight a few key items for individuals to consider before developing a plan:

(1) Follow a logical process when creating a plan and commit to using the plan you develop. This may seem like a “captain obvious” statement, but we’ve spoken with many individuals whose divestment “plan” was random selling when they felt like it—including at times panic selling if/when the stock was falling. When all was said and done, these individuals frequently both (i) had regrets about how they sold their stock and (ii) generated higher-than-necessary tax bills.

(2) Be brutally honest with yourself, and realistic about your company’s potential future performance. One of the biggest challenges we encounter is that many individuals think their company stock is likely to continue to significantly increase in value post-IPO. While it’s certainly possible it could become the next Apple or Google, decades of stock market history indicate it’s much more likely to decline in value than rise meteorically.

To recalibrate your mindset closer to realistic expectations and farther away from “hope-based” expectations — we encourage them to ask/consider the two items below:

Post-IPO public company investors (mutual funds, endowments, pensions, retail investors) are very different than pre-IPO investors (VC funds). Once publicly traded, your company will be valued and evaluated very differently—and declines in value are much more common when publicly traded than private.

Imagine a scenario where you just inherited $1 million after-tax. What are your plans for that money (save it, invest it, spend it)? Stop reading for a moment and consider your answer.

• As you might expect, we get a wide variety of answers to this question. But an answer we pretty much never get is “buy stock in my company”

• What this typically means is that most individuals know they should be selling a significant portion of their company holdings. But a concept called the endowment effect is holding them back. TLDR = They are over-valuing their company stock in their mind because (a) they currently own it, and (b) they invested time/sweat/tears into helping build it.

(3) Build your selling plan around your financial wants/needs + tolerance for risk. For current or former employees of recent IPO companies, it's not uncommon for 30-90% of an individual’s net worth to be held in company stock or options. With the shares now publicly traded and liquid (i.e. can be sold at nearly any time) — it’s critical to deeply consider both (i) your financial wants/needs (e.g. buy a home, pay for children’s college, retire early), and (ii) your risk tolerance. The value of a single publicly-traded company can change rapidly at times; ensuring you take money off the table to cover important wants/needs and sleep better at night (i.e. not taking on an amount of risk you’re uncomfortable with) is essential.

“No Regrets” Selling Plan Framework: Bucket Holdings Into 3 Groups

Selling a concentrated position tends to bring back the age-old investing dynamic: balancing fear and greed. Many individuals we speak with discuss being simultaneously worried about (i) selling too soon and the stock increasing, and (ii) not selling and the stock declining. Needless to say, solving both of these worries simultaneously isn’t possible.

Instead, we focus on creating a plan unique to each individual that minimizes regret by sub-segmenting holdings into three different groups: (1) immediate sales, (2) long-term holdings, and (3) sales-over-time. This framework strikes a balance between the “fear of not selling and the stock declining” (solved via immediate sales) and the “fear of selling and the stock increasing” (solved via long-term holdings), with the final group (sales over time) providing incremental flexibility.

Group 1: Sell Shares Immediately (Typically 30% to 100% of Holdings)

Financial theory suggests that an individual should divest 100% of their concentrated holdings immediately and reinvest them in a diversified portfolio. At 30-40 Wealth we believe this has merit, but also misses the mark by failing to include both (i) individual need/circumstances, and (ii) the behavioral dynamic that this is a company you (very likely) believe in + invested time, sweat, and tears into.

To balance all of these elements, we developed the 6-pronged framework below to help individuals decide how much likely makes sense for them to sell immediately.

Group 2: Hold Shares Long-Term (Typically 0% to 20% of Holdings)

The framework for this group is straightforward, largely depending on an individual’s opinion of the company’s long-term business prospects:

• If you’re not bullish on the company long-term (which is perfectly OK!), we recommend that you don’t keep any holdings long-term.

• If you see certain scenarios where the company could do well long-term, keeping a modest 5-10% of your holdings can make sense

• If you see strong upside potential in the company long-term, we recommend keeping 10-20% of your holdings (but never more than 20%).

Group 3: Use a Selling Plan (Typically 20% to 60% of Holdings)

The percentage of shares that remain, if any, after determining the amounts to sell or keep in Groups 1 and 2 fall into this third group. Within the group, there are typically two primary strategies that are pursued, each of which has pros and cons. Most individuals choose one or the other, but in some cases an individual will do both (i.e. use a selling schedule for half of the shares in this group and a target price strategy for the other half).

(1) Divest the shares via a selling schedule (”price averaging”). This strategy is a commitment to sell a specified number of shares over time. Most frequently, it’s implemented by selling an equal number of shares each month over a period of 12-24 months.

• Key Benefit(s): The selling individual is (i) guaranteed to divest all of the scheduled shares, and (ii) should achieve an average selling price that closely approximates the average company stock price over that time. Most individuals feel that this gives them a “fair price” (i.e. balances the fear of selling too early with the fear of not selling).

• Key Drawback(s): The average price that you’ll ultimately get is unknown.

(2) Set a target price (or prices) for selling the shares (”limit order” or “limit ladder”). This strategy is somewhat the opposite of (1) above. It involves setting one or more target price(s) to sell all of the remaining shares at.

• Key Benefit(s): Stock sales (if they occur) are certain to be at a price-per-share that the seller desired/set

• Key Drawback(s): The stock price needs to rise to/above the target price in order for any shares to sell (i.e. there is no guarantee that any shares will be sold)

Additional Considerations: Tax Optimization

The above “No Regrets” strategy works well but leaves out one important element: tax strategy. When we develop plans, we first follow the process above to align on a target selling plan, and then consider if that plan should be modified in modest ways to optimize for tax. The specific tax optimizations we consider can be nuanced, as there are typically more than a dozen different tax planning items we review and optimize for. A full list of strategies can be found here, but the key ones are:

• Ensures that certain positions meet holding-time requirements to achieve preferential tax treatment (e.g. ISOs qualifying disposition, Qualified Small Business Stock, long-term-capital-gains treatment)

• Pair capital gains from sales with harvested tax losses

• Consider the (likely) multiple different stock tax lots, and strategically selects which lot(s) to sell first/last to lower our client's tax bill

• Optimize for federal and state tax brackets (e.g. adjust the timing of some sales if/when appropriate to not cross into a higher marginal tax bracket)

• Carve out shares that one intends to donate (and realize double or triple tax benefits from doing so)

• Considers and adjust for any anticipated changes in future tax brackets (e.g. state relocation, sabbatical, early retirement)