The Facebook employee’s dilemma
Facebook’s impending IPO is set to make a slew of its employees rich—but exactly how rich depends on the tricky question of how many shares the employees sell, and when.
This dilemma is one that countless employees have faced after their companies have navigated a successful IPO and they’ve cleared the lockup period. This simulator created by a Wealthfront engineer, Jared Jacobs, looks at five typical stock performance patterns: increasing, decreasing, peak-dominated, u-shaped and oscillating. It uses real-life examples based on 10 companies; two companies fit each of the five patterns of stock performance.
The simulator applies four different stock-sale strategies to each company’s stock performance and compared the results to what would have happened if an employee had simply held her shares.
You can see:
• First of all, extreme strategies – sell all or hold all – have the biggest risks and rewards.
• More gradual selling approaches bring good-to-very-good results.
• Your choice of selling strategy matters far more to your portfolio’s long-term success than does the decision about how to invest the proceeds.
The sales strategies used in the simulator are:
-Sell 10% each quarter for 10 quarters
-Sell 10% of the remaining shares each quarter
-Sell 50% up front and 10% per quarter for five quarters
-Sell all shares immediately post-lockup
A quick note: One of the assumptions is that most investors understand the importance of diversifed portfolios, and after an IPO, are looking to sell shares and diversify.
The bottom line, as the simulator reinforces, is that it’s impossible to know the future, even when there’s every reason for optimism. For a short while, Infinera, a telecom equipment maker, was hailed as the next Intel. It’s struggled over the past year, but, who knows? Maybe it will turn out to be the next Intel in the long run.
Companies can also surprise on the upside, of course. Salesforce’s subscription business model had plenty of sceptics at first.
One thing that makes the crystal ball cloudy is the fact that stocks often sink for reasons unrelated to their inherent strengths or weaknesses. Example: Google’s stock sank from $581 a share to $293 between spring and fall of 2008. Its performance suffered because of the financial crisis, and sure enough, the stock eventually posted a strong rebound. But what if you had needed cash to buy a house while shares where plunging? And what if they hadn’t rebounded?
One rational way to approach the uncertainty inherent in any company’s performance in the ungoverned market is to protect yourself against the worst outcomes while still enjoying much of the upside. That means taking a middle-of-the-road approach and selling stock gradually over time.
On thing that’s clear from the Wealthfront simulator: Your investing prowess will not bail you out if you make a bad call on the sell side.
On a $100,000 portfolio, a good decision about when to sell is often more important than earning, say 3% or 9% on your subsequent investments. Take Netflix. The difference between the approach with the highest return (strategy B, in this case) and the lowest (strategy D) is $166,000 over three years. If you sold all your stock immediately after the lockup for a payout of $60,000 and knocked the lights out with a 9% return over each of the three years, you’d only end up with $77,000.
Facebook employees – and those of other tech companies going public in the near future – may well have a reason to celebrate this year – their hard work has paid off. But soon after the celebrations end, it’ll be time to strategize on the right selling strategy.
Interested in embedding?
Feel free to embed the Wealthfront simulator in your own website. You’ll find the code in the upper right corner. If you like the simulator, feel free to use the embed code in the upper right to share it on Twitter, Facebook, LinkedIn or other social media.
If you’re interested in the next iteration of the Wealthfront simulator and our research into the question of when and at what pace to sell your post-IPO stock, please send us a message via email at [email protected], or on Twitter @Wealthfront. We’ll notify you when we’ve completed our analysis. You’re also welcome to ask us to add a particular company to the Wealthfront simulator, because we want help you gather any information that might help you plan your strategy.
Assumptions and notes about the simulator:
Trading windows: The first 180 days after a company goes public is often called the lockup period because employees of the company are not allowed to buy or sell any of the company’s stock. There are also quiet periods around the end of each fiscal quarter during which employees typically cannot trade. Our simulator assumes that fiscal quarters are aligned with calendar quarters and that quiet periods begin 1 week before the end of each quarter and end 3 weeks into the following quarter. The simulator sells stock on the first open-market day after the 180-day lockup period and on the first open-market day of the second month of each quarter thereafter. Waiting until the second month of each quarter avoids some of the volatility that often accompanies earnings releases.
Taxes: We assumed the hypothetical employee in this simulator held all her shares for more than a year before selling them. If you do that, you’re taxed at the lowest possible rate, the long-term capital gains rate (currently 15%). The simulator does not directly incorporate the impact of taxes because taxes affect each strategy uniformly — no one strategy has a tax advantage over any other. That being said, individuals sometimes have unique circumstances that would make one strategy more tax advantageous, so we recommend consulting a tax advisor.
The simulator gathers and presents data from the stock performance of IPOs that occurred from Jan. 1, 2000 and Dec. 31, 2008, and it is not intended to be used as a predictor or guarantee of the performance or outcome of any pending or future IPOs.