What Happens to Unvested Options When a Company Is Acquired?

Stock options are a common component of compensation packages, particularly within dynamic and growing companies, allowing employees to share in the potential success of their employer. As businesses mature, they often become targets for acquisition, a common occurrence that can significantly impact employee compensation. Understanding how these transactions affect unvested stock options is important for employees. This article clarifies what happens to unvested stock options when a company is acquired.

Understanding Unvested Stock Options

Stock options provide an employee with the right, but not the obligation, to purchase a specific number of company shares at a predetermined price, known as the grant or strike price. This price is established when the options are issued and remains fixed, allowing the employee to profit if the company’s share price increases above this amount.

Vesting is the process by which an employee earns the right to exercise their options over a specified period. Companies implement vesting schedules, often spanning several years, to encourage employee retention and align employee interests with the long-term growth of the business. These schedules involve a “cliff” period, such as one year, before any options begin to vest, followed by continuous vesting over the remaining term, often monthly or quarterly.

Unvested options are those that have not yet met their vesting criteria, meaning the employee has not yet earned the right to purchase the underlying shares. Consequently, these options cannot be exercised by the employee. Their future value and accessibility depend heavily on the terms of the acquisition agreement.

Common Outcomes for Unvested Options in an Acquisition

When a company is acquired, the treatment of unvested stock options is a consideration, with several common outcomes determining their fate. These outcomes are negotiated as part of the acquisition agreement.

Acceleration of Vesting

Acceleration of vesting allows unvested options to become immediately exercisable sooner than their original schedule. Single trigger acceleration occurs when all unvested options vest instantly upon a change of control, such as the acquisition itself. This provides employees with immediate access to the value of their equity, though it is less common for broad employee pools and more reserved for executives or key personnel.

Double trigger acceleration is a common arrangement. Under this provision, vesting accelerates only if two specific events occur: first, a change of control (the acquisition), and second, the employee’s involuntary termination without cause or resignation for good reason within a defined period following the acquisition. This structure incentivizes employees to remain with the company post-acquisition while protecting them from losing their unvested equity if their role is eliminated.

Conversion

Conversion of unvested options into equity of the acquiring company is a frequent outcome. In this scenario, the unvested options in the acquired company are exchanged for unvested options or restricted stock units (RSUs) in the acquiring entity. The exchange ratio determines how many new shares or options an employee receives, and the original vesting schedule often carries over, sometimes with minor adjustments, to ensure continued employee retention.

Cash-Out

A cash-out occurs when the company or acquirer pays out the intrinsic value of the unvested options in cash. This value is calculated as the acquisition price per share minus the options’ strike price, multiplied by the number of unvested shares. Upon payment, these options are terminated, providing the employee with immediate liquidity for their equity. The cash payment may be made in a lump sum or paid out over time, potentially tied to a new vesting schedule to encourage retention.

Forfeiture or Termination

Unvested options may be subject to forfeiture or termination without value. This can happen if the options’ strike price is higher than the acquisition price per share, rendering them “underwater” and worthless. Some stock option grant agreements or plans may contain clauses that allow for the termination of unvested options upon a change of control without any compensation. Employees should be aware of this possibility.

Key Factors Influencing Option Treatment

The specific outcome for unvested stock options in an acquisition is shaped by several factors. These elements determine which of the common treatments—acceleration, conversion, cash-out, or forfeiture—will apply to an employee’s equity.

Acquisition Agreement

The definitive acquisition agreement between the acquiring company and the target company is the primary document dictating how stock options are handled. This legally binding contract outlines the terms of the transaction, including the treatment of all outstanding equity, both vested and unvested. The provisions within this agreement supersede other documents and are the ultimate authority on how options will be resolved.

Grant Agreement and Plan Document

An employee’s individual stock option grant agreement and the company’s overarching stock option plan document also play a role. These documents often contain “change of control” clauses that specify what happens to options in an acquisition scenario. The acquisition agreement must then address or align with these pre-existing terms, which can influence the acquirer’s options for treating employee equity.

Legal Structure of Acquisition

The legal structure of the acquisition can also influence option treatment. In a stock purchase, the acquiring company assumes the target company’s existing liabilities and contracts, which may include stock option agreements. In contrast, an asset purchase, where only specific assets are acquired, might result in the termination of existing option plans, requiring the acquirer to issue new equity or cash out options directly.

Negotiation Leverage

Negotiation leverage during the acquisition process is another determinant. The overall value of the target company, the strategic importance of the acquisition to the buyer, and the desire to retain key employees can all influence the acquiring company’s willingness to offer more favorable terms for unvested options. A strong negotiation position by the target company can lead to better outcomes for its employees’ equity.

Employee Role

Finally, an employee’s role and importance within the company can affect how their options are treated. Highly valued employees, particularly those with specialized skills or leadership positions, may have more favorable terms negotiated for their options to ensure their continued employment post-acquisition. These terms might include guaranteed acceleration or more advantageous conversion ratios, reflecting their importance to the combined entity’s success.

Employee Actions During an Acquisition

Navigating an acquisition as an employee with unvested stock options requires proactive steps to understand and protect one’s financial interests.

Review Documents

An initial step is to locate and thoroughly review your specific stock option grant agreement and the company’s comprehensive stock option plan document. These documents contain the foundational terms governing your options, including vesting schedules, exercise rights, and any clauses related to a change of control. Understanding these original terms is essential for interpreting how the acquisition will impact your equity.

Seek Information

Employees should actively seek information regarding the acquisition terms as they pertain to stock options. This involves paying close attention to official communications from human resources, legal, or finance departments within your company. These communications should provide details on how unvested options will be handled, whether through acceleration, conversion, or cash-out, as well as any deadlines for action.

Seek Professional Advice

Seeking professional advice helps to understand the financial and tax implications of any outcome. Consulting a financial advisor can help employees evaluate the overall financial impact of a cash-out or conversion on their personal financial planning. A financial advisor can also assist in strategizing how to integrate the proceeds from options into broader investment goals.

A tax professional should also be consulted to understand the specific tax consequences of option treatment. The tax implications of receiving cash for options or converting them into new equity can vary significantly, impacting whether the income is treated as ordinary income or capital gains, and the timing of these tax events. For complex situations or significant values, legal counsel can provide a review of agreements to ensure all terms are understood and appropriately applied.

Be Aware of Deadlines

Employees should also be aware of any limited windows for exercising options that become vested as a result of the acquisition or a subsequent termination. Acquisition agreements often specify a period during which employees must exercise newly vested options or risk forfeiture. Missing these deadlines can result in the loss of valuable equity.

Maintain Records

Finally, maintaining records of all communications, agreements, and calculations related to your stock options is important. This documentation includes copies of your grant agreements, company-wide announcements about the acquisition, and any personal statements or calculations provided by the company or its representatives. Record-keeping provides a clear audit trail for future reference, particularly for tax purposes or in case of any discrepancies.