Mega IPOs and Mega Concentration

This email is part of a series sharing my “founder’s view” of building Santa Barbara Management. You can catch up on my prior emails introducing our firm here.

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2026 is shaping up to be the year of the mega-IPO. SpaceX successfully launched, clearing the way for the much anticipated potential debuts of OpenAI and Anthropic. Not to mention the other merely “large” businesses waiting in the wings: DataBricks, Canva, Stripe, and so many others.

An IPO creates a unique opportunity and challenge for founders, early employees, and investors: a near-infinite opportunity set of what to do with their newly liquid stock. Usually the post IPO stock represents a significant portion of the founder or early employee’s net worth which amplifies the stakes of getting the decisions right. In the largest IPOs, founders and employees can end up with stock worth hundreds of millions or even billions of dollars.

What creates the challenge is that the founder stock, early stock options, and in-kind carry distributions were acquired for next to nothing and have near-zero basis. This means that essentially every dollar of gross proceeds is taxable on sale.

To be certain, this is a wonderful problem to have. But it is still a situation that demands thoughtful management. Should you look to diversify? How much and how quickly? How should you think about taxes? Are there smarter strategies out there than selling and paying taxes?

The Diversification Question

Selling your stake in the company you built your life around is harder than it looks, for reasons both rational and not:

• Loyalty to the company and its leaders (selling means I don’t believe in them!)

• Emotional attachment

• FOMO (“Fear Of Missing Out”) on future price increases

• Anchoring to the highest price the stock ever printed

• Belief that your deep knowledge of the business derisks the position

• Taxes (I don’t want to sell, because then I hand a chunk to the government!)

Choosing whether to sell is fraught, and I have empathy for anyone facing it. But I keep coming back to Charlie Munger’s advice: “Invert, always invert.”

Here’s a thought exercise. If your concentrated position is worth $250M, imagine instead you have $250M in cash today. Would you put all $250M into this one company at its current price? What about 75%? 50%?

Probably not.

If the answer to that question isn’t a resounding yes, diversification makes sense. A few supporting thoughts:

• Anyone in this position has already “won” financially. The utility of the incremental $100M is trivial next to the pain of falling back to $5M. Nobel prize winner Daniel Kahneman’s research on prospect theory and loss aversion showed that people feel losses much more intensely than equivalent gains, so they demand asymmetric compensation: to accept a coin-flip risk of losing a given amount, they typically require a potential gain of multiples of that amount.
  

• Historical precedence and base rates run against any single stock. In J.P. Morgan’s study “The Agony and the Ecstasy,” covering the Russell 3000 from 1980 to 2014, 40% of all stocks suffered a catastrophic decline: a drop of 70% or more from the peak that was never recovered. Two-thirds underperformed the index. J.P. Morgan estimated that 75% of concentrated holders would have been better off with at least some diversification.
  

• Diversifying is not a vote against the company or a prediction of failure. It just refuses to let one inherently outcome decide your family’s future. Maintaining a substantial position based on conviction is eminently reasonable, and one that I wholeheartedly support. But a cornerstone position within a diversified portfolio is meaningfully different from a single stock portfolio.
  

• You don’t need to diversify all at once - in fact, it likely makes sense to diversify over time for a number of reasons (dollar cost averaging on exit pricing, tax planning). Diversification can play out over several years. It does not need to be an immediate, all-or-nothing transition.

Building a Plan: Putting the Position in Context

We believe the right place to start is with a comprehensive understanding of the position itself. Some of the key questions include:

• Is the stock held directly? Via a fund? Via an SPV? A combination of the above?

  • If the stock is held via a manager, when are distributions expected? Will they be in kind or will the manager sell and distribute cash?

• Are there any restrictions or hurdles to a sale? Examples:

  • Lockups and hedging restrictions

  • Insider restrictions (open windows for trading, reporting requirements, short swing rules, hedging limitations)

  • The stock is a preferred class, sits a transfer agent, and needs to be converted before any sale

• What are the tax attributes of the holdings?

  • Are the holdings common stock? Options? If so, NSOs or ISOs? A mix of the above? Are there any additional grants that will continue to vest over time?

  • How many tax lots are there and what is the basis and hold date of each lot?

Then we contextualize the position within the overall financial picture:

• What does the rest of the balance sheet look like? What percentage of the overall balance sheet does the position represent? What percentage of the liquid balance sheet?

• What liquidity needs exist that may need to be served using this position?

• What is the broader investment opportunity set?

• What are the broader tax considerations?

  • What taxable income is expected this year across the entire ecosystem, entity by entity?

  • Are there any current tax loss harvesting strategies? What about embedded losses elsewhere in the portfolio that could be harvested?

Building a Plan: Fundamental View

It’s impossible to build a good concentrated stock plan without a clearly articulated fundamental view on the stock. The key question to answer is: how much conviction do I have that this stock will outperform the broader market from here over a given time horizon?

If the answer is high conviction, then you can support a plan that keeps a meaningfully outsized (but not entirely dominant) position in the stock.

If the answer is that you do not have high conviction, then there is not a justifiable case for the stock to be an outsized position in your portfolio over the long term.

Building a Plan: Articulating Goals

Armed with the context and a fundamental view, you can articulate your goals. The “goal statement” should include:

• What is the target position size post diversification? As noted above, this may take several years to get there.

• How much liquidity do you need to raise and when do you need the liquidity?

  • This is one of the biggest determinants of which tools are appropriate. Some tools are good for generating liquidity, some are good for deferring tax liability, but relatively few are good at meaningfully doing both.

• What are your near and long-term charitable goals?

Building a Plan: Putting it Together

To turn the theoretical discussion into a tangible action plan, we analyze the data and answers to the above questions to produce the set of diversification goals.

We believe that a programmatic, rules-based plan is critical. It helps to remove emotion from decision making and eliminates analysis paralysis and decision fatigue.

A plan should incorporate:

• Sales over time

• Sales based on price targets

• Forward view of tax liability created and the mitigation strategies

• Ability to update price targets based on fundamentals of business, but not as an emotional response to selling

In some ways, the plans we develop resemble a 10B5-1 or Rule 144 plan that senior executives and board members are required to file when selling securities. But most investors with a concentrated position have the luxury of not filing their plans with the SEC and incorporating actions that go well beyond just the sale of the security (e.g. tax planning).

The Toolkit

There’s a substantial - and growing - toolkit that one can consider in service of achieving the goal statement:

• Just sell and pay the taxes. This is the best way to generate unconstrained liquidity.

• Utilize options to hedge the position - either outright by purchasing puts or in a more cost neutral way by building a collar.

• Run a tax-aware long/short strategy (which I detailed in May) to generate losses that offset the gains from selling shares.

• Use a Variable Prepaid Forward, a forward sale structured as a loan paired with an options position. It hedges the stock, puts cash in hand today (which you can redeploy elsewhere, say into a tax-aware long/short strategy), and pushes the actual sale down the road.

• Utilize an exchange fund to diversify while deferring taxes.

• Use charitable gifting strategies to donate low basis stock without ever incurring a gain on those shares while capturing a deduction you can apply against other sales.

None of these strategies represents a silver bullet, and the optimal strategies for many families employ a number of these tools in concert with one another.

Let’s consider a couple of potential strategies (and note - these can be combined!):

Pair a Variable Prepaid Forward with a long/short extension portfolio.

The VPF does several things at once: It delivers cash today, but defers the tax bill until a future date. You also participate in some upside while protecting some downside until that future sale date. And because it can be settled in either cash or shares, it gives you the option to push the taxable event out even further: settle in cash, keep the shares, and no sale has occurred (assuming you have cash available!).

You can then take the VPF proceeds and fund a long/short extension portfolio. That moves the client into a diversified portfolio and starts generating losses from day one. If you eventually settle the VPF by delivering shares, the losses harvested in the long/short portfolio are there to offset the gain realized at that sale event.

There are meaningful costs to implementing a VPF and a long/short tax loss harvesting strategy: fees and expenses, but also margin, complexity, and potentially legal costs. And with the long/short extension portfolio, you maintain a low-basis portfolio with market exposure.

Donate low-basis stock to a public charity or donor-advised fund (DAF)

Donating low-basis stock to a charity allows two benefits to stack on top of each other.

First, you permanently avoid realizing the gain on the donated stock.

Second, the donor can deduct the full market value. For long-term appreciated stock given to charity, the deduction is the fair market value of the shares, not the cost basis. That deduction offsets taxable income up to 30% of AGI in the year of the gift, with a five-year carryforward for anything above the annual limit.

While charitable giving only makes sense if you actually intend to give the money away (as a standalone tax or investment play it does not pencil), for a charitably inclined donor in a high tax bracket living in a high tax state, the benefits can be meaningful. For a top-bracket New York City resident giving zero-basis stock, the government covers roughly 80 cents of every dollar that reaches the charity in the form of gain avoidance and deduction. The state and federal governments are, in effect, matching your gift four times over.

Pairing charitable giving in a year when you expect meaningful income events (such as from selling concentrated stock) can turn something you wanted to do anyway (giving to charity) into a diversification accelerant.

Utilize an exchange fund to diversify while deferring taxes

An exchange fund pools appreciated stock from many investors into a single partnership and gives each of them a stake in the whole pool. A participant contributes their concentrated position and walks away with a diversified basket with no immediate tax liability.

Exchange funds have been around for many decades as a way to cut concentration risk without a sale. The tax deferral comes from Section 721 of the code, which lets you contribute stock to a partnership without recognizing a gain or loss. Your original cost basis follows you into the fund.

Two critical requirements shape how these funds work:

1. Each investor must stay in the fund for seven years before withdrawing a tax-deferred basket of stock, and an early exit can mean losing the benefit of the tax deferral.

2. At least 20% of the fund’s assets must sit in a qualifying illiquid investments, which is almost always real estate. Most funds are structured to meet this requirement by holding just over 20% real estate and otherwise track a familiar market index with the remainder of assets.

Programmatic Plan: An Example

Typically, our plans involve selling stock ratably over time with a price ladder that acts as an override (e.g. if the stock hits certain higher levels in the interim, sales accelerate) until the position reaches an ultimate “target weight” within the portfolio. The target weight is determined by the fundamental view on the stock.

As an illustrative example, a plan could look like:

• Sell 10% of the position each quarter until the client reaches a 20% target weight in their portfolio.

• Sell 25% of the then remaining position when the stock reaches $50 (illustrative Target Price 1).

• Sell 50% of the then remaining position when the stock reaches $62.50.

• Sell 50% of the then-remaining position when the stock reaches $75.

• Sell the remainder when the stock reaches $100.

We may express these sales in different ways - utilizing VPFs, covered calls, employing tax loss harvesting strategies, or other methods. For example, the first two 10% sales could have the proceeds go directly into a long/short tax aware strategy. And then you could sell covered calls at the target prices.

We believe the requirement to have a fundamental view and then implement a disciplined ladder approach is universal across all holders of concentrated stock. Where the unique tactics that vary with every situation come in is matching the tools to help implement those sales with the required tax profile, liquidity needs, and timeline.

Clients often ask us to provide fundamental analysis of a business and to make a “call” on if they should continue to own the stock or not. While we are happy to benchmark a stock against comparable businesses, to share research and to discuss market dynamics, we urge our clients to approach selling from a different frame of mind: if they do not have extreme, outsized conviction in the business such that they would buy more today, they should approach diversification in a programmatic manner. SBM is not a fundamental equity manager, and even the best fund managers are (very often) wrong in predicting future stock prices. That’s why fund managers own diversified portfolios!

Parting Lessons Learned

In managing single stock diversification programs, we have learned a number of lessons. I’ll share three that have stuck with us:

• The hardest variable is behavioral. While we can model the taxes, build a price ladder, and price a collar, it is much harder to manage emotions that come with having a security that is suddenly marked to market daily, experiencing the volatility of a public stock, and grappling with the implications of parting with the stock that built a fortune. That is why we commit the plan to writing and look to make decisions calmly in advance.
  

• Test multiple service providers. Investment advisors, counterparties for options strategies (calls, puts, VPFs), providers of tax-aware long/short strategy, trust and estate attorneys will vary widely in cost, sophistication, and preferred approach to your situation. Providers lean in on pricing for idiosyncratic reasons at different moments. Approach these decisions the way you would treat hiring a general contractor or choosing a surgeon for a complex procedure. Get a second opinion (or more!).
  

• The best planning happens well before a liquidity event. Trust and estate planning is most flexible and powerful early on at lower valuations and before restrictions are in place. Structures take time to stand up, and narrow what is possible later.

A Closing Thought

When IPOs are ripping and euphoria is high, it can be easy to get caught up in the momentum. Nobody wants to have to get rich twice - and it’s worth remembering the old line “bulls make money, bears make money, and pigs get slaughtered.”

A concentrated position is a wonderful outcome, but can also introduce significant complexity. Our job is not to predict whether your particular stock keeps climbing in the immediate term. We will not know, and neither will anyone else, including the people who run the company or the best equity analysts. Our job is to build a plan that does not require us to know, and instead build resilience in our clients’ balance sheets.

Matt Cohler of Benchmark put it well: “Our job is not to see the future, it’s to see the present very clearly.” In the present you can see clearly your liquidity needs and tax profile, and use Charlie Munger’s inversion to apply a portfolio approach to your holdings. That is the right frame for anyone holding a position they can no longer afford to be wrong about.

Santa Barbara Mgmt., LLC d/b/a Santa Barbara Management is an investment advisory firm registered with the Securities and Exchange Commission (“SEC”) under the Investment Advisers Act of 1940. SEC registration does not constitute an endorsement of the firm by the SEC, nor does it indicate that the adviser or investment adviser representative has attained a particular level of skill or ability. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Form ADV Part 2A can be obtained by visiting https://adviserinfo.sec.gov and searching for our firm name. ADV Form 2B is available upon request. Neither the information nor any opinion expressed is to be construed as solicitation to buy or sell a security or personalized investment, tax, or legal advice.Views are current as of the publication date and are subject to change. Variable Prepaid Forward and long/short extension strategies are complex, involve significant risks, and are not suitable for all investors. Investing involves risk, including the possible loss of principal. Past performance does not guarantee future results. References to specific securities or strategies are for illustrative purposes only and do not constitute a recommendation or solicitation to buy or sell any security.