Welcome to part 3 of 4 in the Klaviyo IPO blog mini-series! This blog focuses on the RSU, ISO and NSO execution strategy when preparing for Klaviyo’s IPO. If you haven’t read part 1 (what to expect with Klaviyo’s IPO) and part 2 (5 mistakes to avoid) then I highly recommend going back and reading those blogs since it will provide valuable context for this blog.
The strategy and execution part of an IPO (aka – cashing in your equity!) can be really challenging. You are wandering into a jungle filled with tactical nuances, especially as it relates to taxes. This blog provides you with some education and framework for how to approach your RSUs, ISOs and NSOs so you can cash-in the equity in a way that is aligned with your life goals, while also minimizing taxes.
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: 5 Mistakes to avoid with the Klaviyo IPO
Part 3 (this blog): Creating a plan for your RSUs, ISOs + NSOs.
Part 4: Pulling it all together… what to do next as the Klaviyo IPO approaches.
Creating a plan for your Klaviyo Restricted Stock Units (RSUs)
As a Klaviyo employee, it’s very likely that you have RSUs and with the IPO, you will now actually vest on those RSUs. When you hold RSUs in private companies, the RSUs are typically subject to “double trigger” vesting which means you need to a) meet the time requirement for working there and b) the company needs some type of liquidity event (such as an IPO). Pre-IPO, you may have met the time vesting requirement, but Post-IPO, you will now meet the liquidity event requirement which officially makes the RSUs vest.
So what happens when the RSUs vest? The value of the RSUs (# of shares * Klaviyo stock price @ vesting) is taxed to you as ordinary income and subject to federal, state and social security tax. Your cost basis in the stock is the value of the stock on the vesting date * the remaining shares remaining. Therefore, there is no tax benefit to holding the stock after the vesting date! Any subsequent sale of the stock will be treated as a short or long-term capital gain (or loss) based upon the initial cost basis. This is a common mistake that we see – many people may hold onto their stock because they fear selling the shares will trigger negative tax consequences… which is not necessarily true!
In other words, you can think of the RSUs like a bonus that is paid to you, but that bonus is paid via stock in your brokerage account instead of cash in your bank account. This reframing can be very powerful because it helps you overcome the status quo of not doing anything upon vesting (and therefore, holding the shares).
For example, let’s compare a $300,000 cash bonus vs. a $300,000 RSU vesting. The end result is the same ($210,000 assuming a 30% tax rate), but one is in cash and one is in stock. However, if you sold the stock upon vesting, you would have cash immediately and the two options would be the same!
Here’s another way to think about it – if you were handed a check for $210,000, would you go buy Klaviyo stock with it? If the answer is no, then you may want to consider selling (at least some) of your RSUs upon vesting. By not selling, you are actively deciding to keep the shares which is the equivalent of taking that $210,000 check and buying the stock!
Creating a plan for your Klaviyo Incentive Stock Options (ISOs)
In addition, to RSUs, you may also have ISOs which are much more complicated. For your ISOs, you are granted a certain number of shares (ex – 15,000) at a pre-specified exercise price (ex – $2). If we assume a $30 stock price for Klaviyo, this means the pre-tax value of the ISOs are 15,000 * ($30 – $2) = $420,000 which is pretty damn good!
Unlike RSUs, ISOs aren’t taxed when they vest and they aren’t even taxed when exercised. Rather, they are taxed when the shares are actually sold. This allows you to have better control over your tax situation, but also requires you to be much more strategic in your decisions.
If you haven’t already exercised your ISOs, you have two main options if you are planning to exercise shares – a) exercise and sell the options at the same time (cash-out the $420,000!) or b) exercise and hold some/all of the options. Why would you consider option B? Introducing the tax benefits of ISOs…
If you exercise and sold the ISOs at the same time, it would be a “disqualifying disposition” which means that the $420,000 gain would be treated as ordinary income, subject to federal and state income tax. If we assumed a 32% all-in tax rate, you would be netting $285,600 after-tax.
However, if you decide to exercise and hold some/all of the options, any subsequent gain is taxed at long-term capital gain rates if a) you hold the shares 2 years from grant date and b) 1 year from exercise date. For simplicity sake, if we assume the Klaviyo is still $30 a year later (unlikely!) and you are subject to a 18.8% assumed long-term capital gains rate, you would be netting $341,040 after-tax which is $55,440 more than the disqualifying disposition.
Does your brain hurt yet? This stuff is confusing. To simplify the Greek I just wrote, the reason to exercise ISOs and hold for 1 year is because you want to take a bet on paying a lower capital gains tax rate via a qualifying sale vs. a higher ordinary income tax rate via a disqualifying sale.
However, the cost of this bet is –
- You have no idea what the stock price of Klaviyo will be 1 year+ from now, so you are exposing yourself to more risk of Klaviyo’s stock price.
- You may inadvertently trigger the “alternative minimum tax” by exercising ISOs (see blog 2: 5 mistakes to avoid for more details).
There are more advanced strategies you can explore with ISOs, but we’ll keep it pretty high-level to avoid the risk of losing you. As you can see, there are many key strategic decisions and tax risks in creating a plan for your ISOs which is why it’s crucial to partner with a qualified CPA and financial planner who can help guide you through this.
Creating a plan for your Klaviyo Non-qualified stock options (NSOs)
NSOs are less common for pre-IPO companies, but you may have some if you were granted a large amount of equity in past years. As with ISOs, you are granted a certain number of shares (ex – 15,000) at a pre-specified exercise price (ex – $2). This is the same example as the ISOs above which would result in a pre-tax value of $420,000.
Whereas RSUs are taxed at vesting and ISOs are taxed at sale, NSOs are taxed at exercise. Upon exercise of the NSOs, the full $420,000 would be subject to federal, state and social security tax (ISOs are not subject to social security tax!) and therefore, there is no tax benefit to holding the shares after you exercise. The cost basis of the NSOs is the value of the stock at exercise and therefore, any subsequent gain or loss is treated as a short or long-term capital gain (or loss). In our experience, there are very little benefits when exercising and holding NSOs – you typically want to exercise and sell right away.
Therefore, the key decision with NSOs is a) when to exercise and sell to take risk off the table and b) how much to exercise which governs how much income you will realize upon exercise. I recommend paying close attention to what marginal tax rate you are in upon exercising. While tax shouldn’t be the main deciding factor on when to exercise and sell, you may want to consider spreading out the NSO exercises depending on your marginal tax bracket and understanding what level of NSO exercise may kick you up into the next tax bracket.
Pulling it all together – how to create a sale plan for your Klaviyo equity
Now that you have a better understanding of the strategic decisions involved with RSUs, ISOs + NSOs, you can begin to formulate a sale plan in a way that minimizes tax, but more importantly, maximizes your life.
The most important part of creating an intentional, life-centered plan for selling your Klaviyo equity is to have a crystal clear “why” for what this money is for in the first place. What will this money be used for? How will it enhance your life? This is the lens through which you want to make the decision on how much equity to keep and how much to sell – it helps you better understand what’s at stake.
For example, let’s say you are planning to use the Klaviyo equity to buy a new home in the near future – do you want to jeopardize this goal by holding your Klaviyo stock in hopes the price will continue to go up? If you have an important life goal that is highly dependent on the money you get from the Klaviyo equity, you likely want to be prepared to sell at least enough to fully fund that goal. In other words, you may have the risk tolerance to hold onto the stock, but you may not have the risk capacity to hold onto the stock.
High life stakes = Lower capacity to take risk.
Low life stakes = Higher capacity to take risk.
For most clients, we typically recommend that you prepare to sell at least some of your Klaviyo equity once the lock-up period is up, even if you have a high capacity to take risk and hold the stock longer. Nobody knows what the stock price is going to do and it’s valuable to cash-in some of your stock so you did something. You don’t know if Klaviyo will be like a Coinbase (went public in April 2021 at $342/share; trading at $82/share as of September 2023) or HubSpot (went public in October 2014 at $29/share; trading at $512/share as of September 2023).
Besides earmarking Klaviyo stock to a specific goal, we also recommend identifying how much of your net worth is now tied up in the Klaviyo stock. If it’s greater than 10% (very likely!), then you may want to consider creating a sale plan that reduces your Klaviyo exposure to 10% – either right away, or gradually over time. For example, if Klaviyo is 30% of your net worth, you may want to consider selling enough to get to 20% in year 1 and 10% in year 2.
But wait… it’s not enough to know how much to sell… you also need to identify what to sell! This is where it gets tricky because the right decision will vary for everyone, but a common starting point is to sell your RSUs first (remember no tax advantages to holding!) and then begin to chip away at your NSOs and ISO where you have more control over the taxation.
At the end of the day, the best decision you can make for your Klaviyo equity is not the one that necessarily minimizes taxes or maximizes net worth… the best decision you can make for your Klaviyo is one that helps move you closer to living your ideal life.
Key takeaways
- You can think of your RSUs like a cash bonus that is simply paid in stock instead of hitting your bank account. By not doing anything (meaning you keep your RSUs), it’s the equivalent of deciding to take money out of your bank account and go buy Klaviyo stock. If you wouldn’t feel comfortable doing this, then you likely want to sell your RSUs upon vest!
- Carefully weigh the pros and cons of exercising and holding ISOs (for lower capital gains tax rates) vs. exercising and selling ISOs right away. If you are taking a bet by exercising and holding ISOs, you likely want to work with a financial planner and CPA to identify whether or not you could inadvertently be triggering AMT.
- The decision of when to exercise NSOs is a bit simpler compared to ISOs since you likely want to exercise and sell right away because the NSOs are taxed at exercise. However, you want to pay close attention to your tax situation and identify whether exercising all NSOs at once vs. spreading it out over a few years may be more beneficial.
- When you are actually able to sell, remember that high life stakes = lower risk capacity and low life stakes = higher risk capacity. You may have a higher risk tolerance, but the risk capacity can be a grounding mechanism for you to better understand if you can actually afford to take the risk in the first place.
- Identify what percentage of your net worth the Klaviyo stock makes up and consider reducing that to 10%, either right away or over-time.
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- Are you interested in exploring how our financial planning services can help you during this IPO process? Visit our home page here to schedule an introductory meeting.
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.
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