Strategies for Concentrated Shares

Liquidating a large stock position can be a daunting proposition.

Most people understand the need to diversify when company stock makes up a huge percentage of their net worth. History has shown that no company is invincible. If titans like General Electric and Fannie Mae can collapse, it can happen to anyone.

At the same time, many fear their company stock could skyrocket immediately after they sell, leaving a trail of regret. Complicating matters, there can be a strong emotional attachment to the stock that interferes with logical decision-making.

Therefore, a lot of thought must go into creating a plan you can stick with.

QSBS Considerations

When the stock is QSBS, there are two additional factors to consider.

First, purchasing protective put options will alter the tax treatment as discussed here. This may pre-empt strategies like cashless collars or similar option-driven approaches.

Second, taxes are less of a consideration. When selling a concentrated stock, sales are often spread across multiple years to lessen the tax implications. With QSBS, however, taxes are less of a consideration, allowing investment decisions can drive the bus.

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All of this calls for a gradual and measured approach. Here are some common strategies for unwinding a concentrated stock position:

Option #1: Time-Driven Approach

A simple and common approach is to pre-schedule future sales of the stock using specific dates and number of shares.

For example, assume Nina owns 10,000 shares of QSBS. She might decide to sell 1,250 shares at the beginning of each quarter, spreading her timing risk over a two-year period. If she has a restricted trading window, she might set her trade date in the middle of each open window to allow post-earnings announcement volatility to subside. 

This approach requires proceeding with the scheduled trades regardless of current circumstances. However, this is much easier said than done. After a good quarter, some wonder why they would ever sell such a wonderful stock. Conversely, after a bad quarter, many feel they should wait for the stock to bounce back before selling.

Anyone following this approach should acknowledge that no one can successfully time markets, so it’s best not to try. They must accept that whether the stock is up or down, it could move even further in either direction. Some quarters will be good, some will be bad, and over time they are likely to cancel each other out.

This approach is highly effective in mitigating timing risk, and the gradual liquidation will ease the emotional difficulty of selling the stock. 

Option #2: Fixed Price Approach

Another approach is to set a series of price targets on both the upside and downside, with no specified timeframe. 

For example, assume Nina’s 10,000 shares are worth $50 each. A fixed price liquidation plan might look as follows:

Upside - enter limit orders as follows:

• 2,500 shares at $60

• 2,500 shares at $70

• 2,500 shares at $80

• 2,500 shares at $90

Downside – enter stop-loss orders as follows:

• 2,500 shares at $40

• 2,500 shares at $35

• 2,500 shares at $30

• 2,500 shares at $25

The advantage to this approach is it can provide a greater degree of certainty. Once all orders are triggered, Nina will walk away with at least $325,000, and as much as $750,000. 

Since the timeframe is open-ended, however, you may end up holding the shares longer than you’d like. In addition, one wild swing in either direction can trigger all your sales. For example, if the company misses earnings one quarter and drops from $50 to $24, it would trigger all the downside sales.

In addition, with any strategy that lacks a timeline, know that the risk to your QSBS tax treatment increases the longer you hold the shares. For example, future Congresses could curtail the benefits of QSBS. In addition, the company might take disqualifying steps, such as using more than 10% of their assets to purchase a non-related subsidiary.

Option #3: Covered Call Options

A third option is to write “out of the money” call options against your shares, providing extra income until they are eventually sold. 

When you write covered calls, you give a third party the right to purchase the underlying stock from you at any time during the contract’s term at a predetermined price. You can choose the strike price or contract length that works for you. For example, you can choose a strike price well above the market price if you’re looking to retain some upside potential. The tradeoff is that as you increase the strike price, you reduce the premium you will earn.

One option contract covers 100 underlying shares of stock. The options are “out of the money” if the strike price is higher than the stock price. 

In general, the wider the gap between the stock price and the strike price, the longer the term must be in order to generate meaningful income. With that, under our example, Nina might write covered calls as follows:

• 25 3-month call option contracts at $60

• 25 6-month option contracts at $70

• 25 12-month option contracts at $80

• 25 2-year option contracts at $90

If an option is exercised, the underlying shares are sold, accomplishing the goal of diversifying. The shares retain their QSBS treatment, and the option premiums are treated as short-term or long-term capital gains. If not, new covered call contracts can be written until the shares are eventually sold.

Before trading options with company stock, be sure to verify whether your code of conduct allows this, as this is often prohibited if you’re still employed. 

Outcome

Like most people, Nina chose to employ a combination of these approaches. 

She chose to start with a lump sum sale of 20% (or 2,000) of shares outright. For the remainder, she opted for a time-driven approach, selling 1,000 shares per quarter over the next two years. She also sold some long-term call options on some of the shares, accepting the extra income as trade-off for the disruption in her schedule if the price were breached.

As always, a pre-defined plan is critical to navigating the turbulent waters that lie ahead. There will be wild swings in both directions, but with a commitment to a sound and gradual strategy, you can minimize any regret you might experience down the road. 

Nothing in this article shall be construed as tax or legal advice. The content is provided for informational purposes only and, there can be no guarantee of its accuracy. Consult your personal advisors prior to acting on any of the information contained in this article.

About the Author

Michael Yoder, CFP® is principal at Yoder Wealth Management (www.YoderWM.com), which provides high-end financial planning and investment advice for individuals and families. You can find more information here.

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