What happens to an employee’s stock options when a company is acquired?

When a company is acquired, the status of an employee’s stock options often becomes a focal point. Stock options can represent a significant portion of equity compensation packages, particularly for employees of startup companies. But the manner in which stock options are treated during an acquisition depends on an array of factors including deal terms, the acquisition structure and company policy. This overview explores some things employees should know about stock options when a company is acquired.

A closer look at stock options in an acquisition

Stock options give employees the right to buy company stock at a predetermined price – the ‘strike price’ or ‘exercise price’. The value of a stock option comes when your strike price is less than the market value of the stock. Stock options are routinely offered as an incentive for employees to remain faithful to a company over the long haul—typically, with their options vesting over time.

Simply put, a vesting schedule is a timeline over which an employee gains ownership of the options, often over a period of several years. A typical stock option vesting period is four years with a one-year cliff, meaning 25% of the options vest after the first year, and the remaining 75% vest gradually over the next three years.

When a company is acquired, the acquiring company can offer to purchase the stock options from the employees, exchange them for options in the new company, or nullify the options altogether—all depending on the terms of the acquisition.

What employees can expect with stock options post-acquisition

Employees typically experience one of the following three potential outcomes:

1. Cash-out

The acquiring company may elect to buy out the stock options in cash, usually based on the company’s acquisition price and the options’ exercise price. If the acquisition price is higher than the options’ exercise price, employees may profit from the difference in this scenario. This commonly occurs when the company is sold for a premium.

2. Stock swap

Another common occurrence is a stock swap, where an employee’s stock options are converted into options for the acquiring company’s stock. The number of options and the exercise price are often based on pre-determined formulae spelled out in the acquisition terms.

3. Cancellation

If the acquisition fails to provide for a cash-out or stock swap, the stock options may be canceled. This sometimes happens if a company is acquired for less than its market value or if the acquisition terms do not account for the options. In such situations, employees may lose the potential stock options’ value, particularly if they’re unvested.

What happens to unvested options in an acquisition?

During an acquisition, unvested options present a challenge. That’s because vesting schedules typically include a ‘cliff’ period (i.e., after one year, after two years, etc.) and/or gradual vesting (i.e., monthly or annually) over a several-year term.

The fate of unvested options can vary depending on the terms of the acquisition. The following scenarios may occur:

1. Acceleration of vesting

The acquirer may expedite the vesting of unvested options. This means employees may be immediately granted some or all of their unvested stock options independent of the original vesting schedule. This action is intended to incentivize employees to stay with the company after the acquisition.

2. Cancellation with severance or payout

In some cases, unvested options might be canceled. But employees might receive severance, more compensation, or a payout for their unvested options. This action is intended to incentivize employees to remain during any transition period, or if the acquired company is being sold with no plans to continue operating.

3. Conversion into acquirer’s options

The acquirer may convert unvested options into options for its own stock—usually under a modified vesting schedule. This move is intended to align employees with the new company’s success while still honoring their previous compensation deal.

Factors that influence the treatment of stock options

The following factors influence how stock options are treated in an acquisition:

• Type of acquisition

Whether the acquisition is an asset purchase, a merger, or a stock purchase can materially impact how options are handled.

• Negotiation terms

The fate of stock options is sometimes negotiable. High-level employees may secure better terms for their options than others.

• Company policies

Post-acquisition treatment of stock options is often baked into company policies.

Summary

After an acquisition, the treatment of stock options is dependent on the terms of each unique deal. While certain employees may see their options cashed out or converted into new options, others might lose their unvested options completely. Understanding the terms of your options is essential to making the right choices to benefit your financial future.

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