One employer, one stock, one tax year
Concentration risk simply means a portfolio depends too heavily on a single stock, sector, or employer — the opposite of the diversification principle that spreads exposure across many independent bets so no single outcome can sink the whole. Most pre-IPO employees are already concentrated: a meaningful share of their net worth, plus their paycheck, is tied to one company’s fortunes. An IPO doesn’t create this exposure so much as it makes it visible, taxable, and time-stamped — often in a single year.
That’s because the equity itself isn’t one simple instrument. Employees at growing pre-IPO companies commonly hold some combination of restricted stock units (RSUs), incentive stock options (ISOs), and nonqualified stock options (NSOs), and each has its own tax trigger. RSUs — especially "double-trigger" RSUs that vest only once a liquidity event like an IPO occurs — can convert years of accumulated grants into ordinary income all at once, producing what one wealth advisor quoted by NerdWallet calls "an enormous income year". ISOs defer taxation until sale but can trigger the alternative minimum tax (AMT) upon exercise, taxing paper gains on shares you haven’t sold and, if the stock later falls, may leave you owing tax on value that no longer exists. NSOs are taxed as ordinary income at exercise, with capital gains layered on top at sale. Holding a mix, which is common after several years at a fast-growing startup, compounds the complexity rather than simplifying it.
The withholding gap: why the paycheck feels bigger than it is
The most common trap isn’t ignorance of these tax categories — it’s assuming that automatic tax withholding equals the actual tax bill. Employers typically withhold on vesting RSUs at the IRS’s default supplemental rate of 22% (37% above $1 million in supplemental income in a year). For an employee whose true marginal tax bracket is higher, that default withholding simply won’t cover what’s ultimately owed, creating a bill that surfaces months later at tax time — not a flaw in the system, but a mismatch between a flat default rate and a genuinely progressive tax structure. Note that this cuts both ways: the same default rate can also lead to overwithholding for some employees, meaning shares get sold to cover taxes that weren’t actually necessary, cutting into future upside from stock that could have been kept. Neither outcome is universal; the right number depends on total income, deductions, and state taxes, which is exactly why this is a case for individualized calculation rather than a fixed rule of thumb.
This is where the concentration story sharpens: the very event that’s supposed to prove your equity’s value is also the event most likely to force unplanned selling, unplanned tax payments, or unplanned decisions about which shares to exercise — all before you’ve had time to step back and ask whether your portfolio is dangerously tilted toward one employer.
Locked in when it matters most
Even employees who want to rebalance immediately after an IPO usually can’t. A lockup agreement restricts company insiders, including many employees, from selling shares for a set period after the IPO — commonly around six months, though the exact terms vary by company and offering structure. And the lockup isn’t necessarily the last hurdle: companies can also impose blackout windows around earnings releases or other material events, further narrowing the calendar days on which an employee is legally permitted to sell. The result is a gap — sometimes a long one — between the moment equity becomes taxable income and the moment it becomes a saleable asset. During that gap, the employee’s net worth is fully exposed to a single stock’s price swings, with taxes already owed (or accruing) on value that cannot yet be converted into anything else.
Mapping the friction points
It helps to separate constraints that affect when you can sell from constraints that affect what you’ll ultimately owe, since conflating them is a common source of confusion:
| Friction point | What it actually restricts | When it typically hits |
|---|---|---|
| Vesting (esp. double-trigger RSUs) | Nothing directly, but creates a large one-time income event | At IPO or vesting date |
| Withholding rate (default 22%/37%) | Cash available now, not final liability | At vesting, settled at tax filing |
| AMT exposure (ISOs) | Cash needed to cover tax on unrealized gains | At exercise, settled at tax filing |
| Lockup agreement | Legal ability to sell shares | Roughly months after IPO, varies by company |
| Blackout windows | Legal ability to sell shares | Recurring, tied to earnings/material events |
Notice that only two of these five rows govern actual liquidity (lockups and blackout windows); the rest are tax-timing issues. Treating a tax question as if it were a liquidity question — or vice versa — is exactly how employees end up either under-planning for a tax bill or overestimating how soon they can diversify.
A sequence, not a single decision
Because these constraints stack rather than substitute for one another, diversification after an IPO is better understood as a sequence of checks than a single yes/no choice:
flowchart TD A[Equity vests or IPO occurs] --> B[Estimate true tax liability] B --> C[Check withholding vs. liability gap] C --> D[Confirm lockup / blackout status] D --> E[Assess concentration vs. total net worth] E --> F[Consider partial diversification, if permitted]
Each step gates the next. Skipping the tax-liability estimate to jump straight to "should I sell" risks a cash shortfall later; skipping the lockup check risks planning a sale that isn’t legally possible yet. The concentration assessment — asking what share of total net worth this one company now represents — belongs near the end of the chain, once the actual liquidity window is known, not at the start.
What this framework doesn’t tell you
None of this establishes when a specific employee should sell, nor does it suggest that diversifying always beats holding, or that holding always beats diversifying — the sources underlying this analysis don’t quantify outcomes either way, and no general framework can substitute for a calculation based on someone’s actual holdings, filing status, state tax exposure, and broader financial plan. Diversification, when it’s eventually possible, reduces the impact of any one stock on a portfolio; it does not guarantee gains or protect capital from a broad market downturn.
The real lesson of an "enormous income year"
The unsettling truth about an IPO windfall isn’t that the wealth is fake — it’s that the wealth arrives bundled with obligations and restrictions that most people don’t see until they collide. A number on a brokerage statement can represent genuine value while simultaneously representing a tax bill you haven’t fully accounted for and shares you’re not yet allowed to sell. Recognizing that gap — between paper wealth and usable, diversifiable wealth — is the first step toward managing concentration risk deliberately, rather than discovering it the hard way when the lockup lifts and the tax return comes due at the same time.
