Welcome to part 2 of 4 in the Klaviyo IPO blog mini-series! This blog focuses on the 5 main mistakes to avoid when preparing for Klaviyo’s IPO. If you haven’t read part 1 (what to expect with Klaviyo’s IPO), then I highly recommend going back and reading that blog since it will provide valuable context for this blog.
In our experience helping clients navigate the exciting, confusing & stressful journey of an IPO, we’ve identified a handful of mistakes that we’ve seen people make (or nearly make!) that typically apply to the majority of folks in a similar situation.
As a reminder, this blog mini-series will be broken down into the following parts to help you best prepare for the IPO:
Part 1: The logistics of the Klaviyo IPO and connecting the IPO event to your life goals & values.
Part 2 (this blog!): 5 Mistakes to avoid with the Klaviyo IPO
Part 4: Pulling it all together… what to do next as the Klaviyo IPO approaches.
Mistake #1: Making major life decisions before the lock-up period is over
As it relates to the IPO, “the waiting is the hardest part”… RIP Tom Petty. The psychological rollercoaster of an IPO is truly one of the most difficult to stomach. Once Klaviyo goes public, you may log into your account and see a life-changing dollar amount.
The only problem is a) you can’t touch the money until the lock-up period is over and b) the money is pre-tax. Therefore, I strongly recommend that you fight (the very natural!) urge to make any major life decisions until the lock-up period is over.
Thinking about using the money to buy/upgrade a home? Wait.
Dreaming about a fancy new car? Wait.
Contemplating leaving a job/starting a business? Wait.
About to book that dream trip to Antarctica? Wait.
Now, this does not mean you shouldn’t celebrate – this is likely a major professional & financial accomplishment for you! Go out for a fancy dinner. Treat yourself to something nice. However, it’s crucial to fight the urge to drastically change your life until you actually know how much money (after-tax!) you will have once the lock-up is over.
Mistake #2: Under-withholding taxes on your Restricted Stock Units (RSUs)
RSUs are relatively straightforward. Once they vest, the value of the RSUs are taxed to you as ordinary income (just like wages) and then you can sell the shares (assuming you aren’t subject to trading restrictions). For example, if you have 7,000 RSUs vesting and Klaviyo is $50/share, then you have $350,000 of ordinary income where federal & state taxes will be withheld.
Sounds pretty simple, right?
The issue is that RSUs are treated as “supplemental wages” for federal tax purposes which means unlike your actual salary (where your form W-4 informs your tax withholding), taxes are withheld at a statutory 22% federal rate up to $1 million of income. The key word here is withheld – RSUs are taxed the same as your normal salary, but they are withheld differently. So for the 7,000 RSUs vesting at $50/share, you would have 7,000 * 22% = 1,540 automatically sold upon vesting to cover the federal income tax withholding and the remaining 5,460 shares would be deposited into your account.
This statutory 22% federal is one of the most common reasons why people with equity compensation owe a surprise tax bill when they file their taxes. If their actual effective federal tax rate is greater than 22% and their RSUs were withheld at 22%, then you will very likely owe taxes!
This is especially important in the year of an IPO because it’s very likely that a high percentage of your total income for the year will come from the RSU vesting. Here’s an example showing a $400,000 base salary with $350,000 of RSUs vesting in 2024.
As you can see, this person would be on the hook for $45,500 of federal income taxes! The reason for this tax bill is the 22% withholding on the RSU income. At $400,000 of base salary, your assumed effective federal income tax rate in this example is about 20%, but your marginal federal income tax rate is 32% (meaning every extra $1 is taxed at 32%). However, since the RSUs are withheld at 22%, it means you are under-withholding roughly 10% (32% – 22%) on every $1 of RSU income above the $400,000.
Now, companies (especially in the year of the IPO) recognize this issue and will often give you a choice on how much tax you want to withhold from the RSUs – typically ranging from 22% to 37%. Sometimes it’s 22% or 37%… and sometimes you have options in the middle. Let’s assume you have an option in the middle at 32%.
You have 3 main options –
Option 1 – Highest risk: Do nothing and use the default 22% rate. From a behavior financial standpoint, this may seem like the easier choice because it’s the default option. However, by keeping the 22% rate, you are basically saying “hey – please purposefully under-withhold taxes so I can keep more Klaviyo stock”. This could be an option, but you really need to be strategic on a) identifying how much tax you will owe, b) determining how you will come up with the cash to pay it and c) discussing the impact of the stock price going down on your life goals (ex – a new house). You won’t be happy if you are forced to sell Klaviyo stock when the price is down to pay for the tax!
Option 2 – Lowest risk: Elect the 37% rate. If you want to cash-in on your Klaviyo stock ASAP and avoid a surprise tax bill, this may be your best option, especially if the risk of Klaviyo’s stock price going down may seriously impact some of your life goals.
Option 3 – Medium risk: Elect the 32% rate. This is hedging your bet a bit by saying “hey – I don’t want to be hit with as large of a tax bill, but I also don’t want to sell more Klaviyo stock than I need to”. If you feel like the risk of Klaviyo’s stock price has a medium impact of some of your life goals, this may be a good option for you.
The other big variable here is you won’t actually know how much your RSU taxable income will be because you don’t know what the stock price will be at vesting! You can see how there are several key decisions at play here – your tax situation, risk tolerance, life goals, projected Klaviyo stock price, etc. so it’s crucial that you fully weigh your options and avoid just sticking with the default withholding rate (likely the 22% withholding rate!) without thinking everything through.
Mistake #3: Triggering an unexpected tax bill by exercising your Incentive Stock Options (ISOs)
Unlike RSUs, ISOs are a lot more complicated. With ISOs, you have the option to buy a pre-specified number of shares at a pre-specified exercise price. Especially if you are an early employee at Klaviyo, it’s likely that your exercise price is very low which means that your ISOs could be hugely valuable upon the IPO. We’ll dive deeper into your ISO exercise strategy in our next blog, but for now, we’ll focus on the dreaded tax in ISO world called the alternative minimum tax or AMT.
Without diving too deep into the weeds, AMT is a separate federal (and sometimes state) tax calculation that runs next to the traditional tax calculation. If the AMT is greater than the federal/state tax calculation, then you pay the AMT amount. If the AMT is lower than the federal/state tax calculation, then you pay the federal/state tax amount.
Nowadays, it’s pretty rare for people to pay AMT, but ISOs can inadvertently trigger it. Why? Because the difference between the fair market value of Klaviyo (either the current 409(a) pre-IPO or current stock price post-IPO) and the exercise price, multiplied by the number of shares is treated as “AMT income”.
For example, if you have 10,000 ISOs at $5/share and you exercise the ISOs when Klaviyo is $50/share, then you have 10,000 * $45 ($50 – $5) = $450,000 of AMT income. Not only could this trigger a massive AMT tax, but you may not have the ability to sell additional shares (either via the lock-up period or a blackout period) to pay the tax!
Before exercising ISOs, I highly recommend working with a financial planner and a qualified CPA to ensure you aren’t inadvertently triggering a huge tax that you may not have the cash to pay for when taxes are due for 2023.
Mistake #4: Not planning for a large tax bill after selling your previously exercised ISOs
Now, let’s say you got ahead of the AMT game and already exercised your ISOs – either intentionally to avoid future AMT or perhaps you left Klaviyo at some point and had to exercise shares or else you lost them. What happens when you sell your shares after the lock-up period?
Let’s say you have 10,000 shares that you previously exercised at $1/share and you sell the shares for $50/share after the lock-up. The good news is that you’ll immediately cash in $500,000. The bad news? You’ll likely owe short-term (if the shares were exercised <1 year ago) or long-term capital gains (if the shares were exercised >1 year ago and >2 years since the grant date) tax on the 10,000 shares * $49 ($50 – $1) = $490,000. If we assume a 30% all-in federal and state long-term capital gain tax rate, then you will be on the hook for $490,000 * 30% = $147,000 of tax!
Unlike with RSU vesting, there will be exactly $0 of tax withheld upon the sale of your shares which means the responsibility is on your shoulders to a) identify how much the tax will be and b) specifically earmark that money for taxes so you think of it as already “spent”. In other words, don’t plan to use the full $490,000, but plan to use $490,000 – $147,000 = $343,000.
But wait! If you were an early employee of Klaviyo and exercised shares a long time ago, your ISOs may be eligible for a tax exclusion called “Qualified Small Business Stock” or “QSBS”. Under QSBS, your entire gain may be federal and state tax free if you have held the shares for >5 years and Klaviyo met the criteria for QSBS (which is something you can ask Klaviyo) when you exercised. This can be a life-changing savings on a potential tax bill and should be explored by all Klaviyo employees who already hold previously exercised ISOs.
Mistake #5: Anchoring your sale plan to Klaviyo’s previous all-time high
We cover creating a sale plan for your Klaviyo equity in blog 3, but the concept of anchoring is worth mentioning here. While we hope that Klaviyo’s stock price will be its highest when the lock-up period ends, it’s very possible that when it comes to sell, you may not be selling Klaviyo at its highest point.
That means you should wait for it to return to the highest price, right? If you don’t sell at the high, you’ll be leaving money on the table, right? Wrong.
One of the most harmful mindsets you can adopt is only planning to sell at the highest price. This could leave you waiting months… years… indefinitely. Nobody has any friggen clue. Professional financial “analysts” may set price targets for Klaviyo, but truth be told, these price targets are completely useless as nobody can predict what Klaviyo’s stock will do on a consistent basis.
As we discussed in blog #1, the most important thing you can do is create your “why”, so you have a lens through which you are looking through when making the Klaviyo equity decisions. Instead of trying to maximize your net worth, focus on maximizing your life. This may very well mean that you aren’t selling Klaviyo at its high point. It may go up 20% after you sold and that may sting. However, it could also go down 20% which could jeopardize your life goals.
Ask yourself this question – How would your life goals be impacted if Klaviyo increased an extra 20% from its current price? How would your life goals be impacted if Klaviyo decreased 20% its current price? For most, the downside risk of Klaviyo’s stock price declining has far bigger implications on their life goals vs. the upside potential of Klaviyo’s stock price increasing.
Therefore, I encourage you to start adopting the mindset that you won’t sell at Klaviyo’s peak… and that’s okay. In 10 years, you’ll remember the life goals you were able to accomplish with the money, not the extra 10% you could have gained by waiting a bit longer to sell.
Key takeaways
- All roads lead back to your “why” for the IPO in the first place. It’s critical to have a (flexible) vision for an ideal life when making the key IPO decisions, but you likely want to avoid any major life decisions until after the lock-up period is over. At that point, you’ll have a better idea how much of the Klaviyo stock proceeds will ultimately hit your bank account.
- Avoid doing nothing as it relates to your RSU withholding decision. This is a crucial decision that will be different for everybody, but you want to weigh the 3 options (low, medium + high tax withholding) that we outlined above.
- Work with a financial planner and a CPA before executing your ISOs. The AMT tax is really complicated and you want to avoid triggering a large tax bill that you may also not have the liquidity to pay.
- For your previously exercised-ISOs, remember that tax will not be withheld when you sell your shares. Earmark the estimated tax due from these shares, put the cash in a high-yield savings account and think of the money as already “spent”. Be sure to also inquire whether or not your Klaviyo shares meet the criteria for QSBS – this can be a massive opportunity to save on tax!
- Adopt the mindset that you won’t be selling Klaviyo at its all-time high… and that’s okay. Your life goals should drive the decision when & how much to sell… not trying to “time” it perfectly.
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About Experience Your Wealth, LLC
EYW was established in 2019 – our home “offices” are based in Rhode Island (Jake), Tennessee (Marie) and Arizona (Mike + Lillian) as we operate remotely and work with clients from all around the US.
We provide virtual, fee-only financial planning services to travel-loving young families who don’t buy into the traditional “9-5, work-until-you’re-65” concept. We help you find the responsible balance between paying down debt, investing for the future, but also experiencing life now.
We have deep expertise as it relates to equity compensation, including existing knowledge & familiarity with Klaviyo’s equity.
Our team includes Certified Financial Planners (CFP®), Certified Student Loan Professionals (CSLP®), a Chartered Financial Analyst (CFA) and a former Certified Public Accountant (CPA) as we love to nerd-out on the technical side of financial planning, but our true passion lays with the “personal” side of personal finance – helping our clients articulate & visualize their dream life and then best align their financial decisions with their life.
We’re shaking up the financial planning industry by bringing modern, life-centered financial planning advice and personal CFO-level service to our clients. We are completely remote, paperless and meet clients over Zoom with frequent guest appearances from kids, dogs, cats and whatever fun animals that may be around your home.
Disclosures
None of the information provided is intended as investment, tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement, of any company, security, fund, or other securities or non-securities offering. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information is at your sole risk. The content is provided ‘as is’ and without warranties, either expressed or implied. Experience Your Wealth, LLC does not promise or guarantee any income or particular result from your use of the information contained herein.
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