Unicorns Stampeding for the Exits

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Uber, Lyft and Pinterest are all expected to go public this year, with Lyft first out of the gates at the end of this month. There’s lot of anticipation and excitement for these IPOs, including:

  • Public investors, who are anxious to participate in the continued growth of these companies;

  • Venture capitalists, who are looking for public market validation of the enormous private valuations they’ve assigned to these and other unicorns;

  • Bay Area residents, who expect a flow of newly-liquid riches into local businesses and real estate; and of course

  • Employees at these firms, who will have a greater ability to realize the wealth in their options and RSUs

Given the tech-centric nature of our client base, we’ve had many conversations with employees at these and other unicorns about how to prepare for an exit and what to do once they’re able to sell their shares.

We don’t believe in a “one size fits all” approach to how we advise clients, but there are some questions that we help answer on a regular basis:

How much of my company stock should I sell or hold?

There are multiple facets to this question, and the particulars of both the client’s situation and goals, and the company’s stock, influence how we answer this. The biggest driver of the answer is determining the portfolio risk/reward profile that’s needed to help the client have a successful long-term plan.

Is there anything we can do to limit the tax bill?

Taxes are a factor in almost every financial decision. We advise clients on strategies ranging from early exercise (83b), utilizing Investment Credit Lines (ICLs) to delay cap gains realization when purchasing property, exploring qualified opportunity zone (QOZ) investments to delay/avoid cap gains, and whenever possible, certifying Qualified Small Business Stock (QSBS) treatment to eliminate capital gains completely.

Is buying a house a good idea?

Real estate purchases are one of the most consequential financial decisions you can make, especially in high cost areas like the Bay Area. We help clients determine how a home purchase fits into their plan, including what they can afford and how their preferred career path (larger company vs younger start-up) can influence their financing decision.

What am I probably not thinking about that I should be?

We get it – our clients are busy and have a lot on their minds. In addition to helping answer their direct questions, part of our role is addressing issues that may not even be on their radar. Do we need to revisit your estate plan or liability coverage in light of this windfall?  Will a 10b5-1 plan help insulate you from insider trading risk now that the company is public?

 

Single Stock Concentration and Financial Planning

It can be hard to fault someone for choosing not to diversify their company stock when companies like Google, Facebook and Amazon have performed as well as they have in the last decade.  If the proceeds from that potential diversification is earmarked for something like bonds, the reaction could well be, "how will that ever generate a higher return than my RSUs?"

And herein lies the problem.  There is a subtle but significant distinction between maximizing expected return, and trying to maximize the odds of reaching or maintaining a certain value for your portfolio over time.  The former is fueled by risk, and has no optimizing upper bound.  The latter will always have an inflection point beyond which taking more risk to generate more expected return will actually *lower* the probability of meeting a certain minimum value (say $1 or more by age 100).

And individual stocks are quite a bit more volatile than even broader equity benchmarks:

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Virtually every financial advisor, robo-advisor and portfolio optimizer out there are either ignoring all of your stock that makes up the dark grey curve ... or they are making a simplifying assumption that your single stock doesn't have that shape at all, and instead behaves just like  the orange curve.  Both result in dramatic underestimates of risk -- which then lead to overly aggressive investment choices outside of your company stock.

Why don't firms model single-stock positions more accurately?  Because the amount of stock concentration differs greatly across clients - and changes frequently due to vesting and performance of the stock.  So it is a lot of work to build an optimized allocation around each client's concentrated stock position.  The industry is built for scale - not customization.  So treating Google the same way as the S&P 500 (or worse, ignoring the fact you own it at all) becomes the norm.

Despite the systemic under-valuing of risk in portfolios, this rarely means those individuals should sell all of their single stock positions.  It simply means they need to objectively evaluate the proportion that serves them best in reaching their goals.  And to the extent that proportion is lower than their current holdings, determine the most efficient way to manage that risk.  Sometimes that means selling shares.  Other times it means using an option strategy to narrow the possible return outcomes.  Still other times it means using an exchange fund to "swap" your company stock for diversified market exposure (without triggering capital gains).  There are a number of strategies available -- but the first critical step is modeling the shares you hold accurately, and then determining the amount of stock concentration that serves you well in reaching your goals.

If your current investment strategy is not accurately analyzing your stock concentration, contact us to schedule an appointment, and get a clearer picture of your optimal portfolio.

Unicorn Valuations

While some have thrived, other large “unicorns” have had a bumpy ride these last two years. A cap-weighted portfolio of the 15 largest US unicorns in Jan 2016 would have returned approximately 7% to today, compared to a 36%+ return for the S&P 500.

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