Snowflake’s Lockup is Ending: Prepare for an Emotional Roller Coaster

 In Equity comp, Snowflake

After guiding clients through their company’s IPO and the subsequent lockup, I wanted to share lessons from their experiences. You’ll learn about the three mental traps I’ve observed as clients wait for the lockup to come off. And I describe how to counter these thoughts.

Next week, I’ll be writing about where to go for advice and guidance.

What is a Lock-up Period?

Snowflake went public in September 2020, but for the last three months, you couldn’t sell your stocks. This is because a lock-up period applied in which you were forbidden from selling shares. Starting tomorrow, you’ll be able to sell 25% of your vested options and shares in December 2020.

Starting in January 2021, you’ll again be subject to a lock-up period. And your next opportunity to sell shares will be in March 2021 when the lockup fully comes off.

Three Mental Traps

It’s tough to make smart decisions when you face so many unknowns. What will SNOW’s price be when the lock-up comes off for the last two weeks of December? Will it move up or down between December and March? And what about after March?

I’ve helped clients through IPOs where the stock price skyrocketed up (Cloudflare), and where the price dropped shortly after the IPO (Lyft, Uber). Either way, I’ve consistently noticed these three mental traps.

In behavioral finance, these are also known as “heuristics” or “mental shortcuts.”

Insider Optimism Syndrome

I want to keep my shares because I believe in my company’s prospects

I hear this refrain all the time. Now, a lucky few might be able to afford the risk of keeping all of their company stock. For example, if someone wants to work forever and spends little money, they can attain their financial goals based on their savings ability. Their long-term success doesn’t rely on their company stock whatsoever.

For everyone else, I reframe the issue as follows: “If your company paid $100,000 cash bonus, would you use this money to purchase company stock?” Most clients quickly answer, “No, I’d keep the cash.”

If you answered “No,” then you should think of the stock compensation as a bonus that happened to be paid in shares rather than cash. This is particularly true for vested RSUs. In other words, sell all the shares immediately; your company will withhold taxes, and you keep the remaining cash.

The endowment effect, a behavioral economics term, explains this effect: people will value something that they already own more than a similar item they don’t own. The endowment effect describes people who own company stock and are unwilling to sell those shares, even though they don’t care to buy the stock if they were paid a cash bonus.

Special Note on ISO Shares

It may make sense to hold your ISO shares for at least one year from the exercise date due to the tax savings.

You receive favorable capital gains tax treatment if you meet two holding period rules:

  1. You sell the shares at least two years two years from the grant date, and
  2. At least one year one year from the exercise date

A potential landmine for ISOs is AMT. The Alternative Minimum Tax (AMT) rules are complicated. In a nutshell, you must calculate your tax bill twice: under the regular rules, and under the AMT rules. Each year, you must pay the higher of the two. Assuming you keep the shares beyond 12/31 in the year of exercise, the spread (fair market value on the day of exercise minus the strike price) isn’t subject to regular income taxes, but it counts as income under the AMT system.

Breakeven-itis

I want to hold out for the ‘right’ stock price before I sell

Beware the temptation of waiting to sell until you get the “right” price of “at least” $360 or whatever you’re anchoring on. This can lead you into a trap of never selling the shares. If the stock price reaches your target, you might be tempted to set a new target price. Or if the stock price drops, I’ve seen clients express regret about selling “if only” the price were “at least” a stock price that was distantly in the rear view mirror.

Your personal goals and values should drive your decision about what to do with your stock. If the current stock price allows you to achieve your goals, then sell now.

Here are common examples that I hear from clients, and maybe some of these will resonate:

  • Take a sabbatical
  • Buy a house (or a second house)
  • Help family and/or friends financially
  • Support important causes at a far greater level
  • Leave the workforce altogether (particularly for earlier employees)

Regret avoidance

What if my company becomes the next Google or Amazon? I’ll kick myself for selling!

FOMO is human nature. It’s easy to judge decisions in hindsight. But you don’t have the benefit of hindsight right now. It’s difficult to predict stock prices; even investment professionals get it wrong most of the time. Warren Buffett himself recommends that investors select index funds rather than finding a professional manager who likely will perform worse than an index fund after fees.

A solution is to keep a small portion of your shares. Select an amount you’re okay with losing. For example, what started as $25,000 of stock could drop to $15,000 in a short period of time. Keeping a toehold in your shares can help you avoid regret in case the stock is a home run like Google or Amazon. And sell the rest for taxes, your emergency fund, debt repayment, and other goals.

To learn more about the Snowflake IPO, here are all of the posts in this series:

  1. Blessings (and Burdens) of a Financial Windfall
  2. Donating Snowflake Stock: Help Charities, and Benefit Financially
  3. Snowflake Incentive Stock Options
  4. Snowflake’s Lock-up is Ending: Prepare for an Emotional Roller Coaster
  5. Snowflake RSUs
  6. Which Financial Professional Should You Hire?
  7. Prepare for the Full Release in March 2021

DO YOU WANT ONE-ON-ONE GUIDANCE ON YOUR SNOWFLAKE EQUITY? SCHEDULE A CONSULTATION IF YOU’D LIKE TO WORK WITH A TAX-FOCUSED FINANCIAL ADVISOR WHO SPECIALIZES IN EQUITY COMPENSATION.

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