What Happens to Unvested Stock Options When a Company Is Acquired?

Stock options are a form of equity compensation that gives an employee the right to buy a specific number of shares of the company’s stock at a predetermined price, known as the exercise or strike price. Companies frequently include these options as part of a compensation package to allow employees to share in the business’s success. The value of these options often depends on the company’s stock price increasing above the strike price, enabling potential profit upon exercise and sale. When a company undergoes an acquisition, the treatment of these stock options becomes a significant consideration for employees.

Basics of Unvested Stock Options

Unvested stock options refer to equity awards that have been granted to an employee but are not yet fully earned or exercisable. Ownership of these options is conditional upon the employee fulfilling specific requirements, typically continued employment over a period or the achievement of performance targets. Until these conditions are met, the options cannot be exercised, sold, or transferred, meaning they do not hold immediate realizable value for the employee.

Companies implement vesting schedules to incentivize employees to remain with the company and contribute to its long-term success. The most common type is time-based vesting, where a portion of the options vests incrementally over a set period, often four years. This frequently includes a “cliff” period, such as one year, during which no options vest. After this initial period, a significant portion vests, with the remainder vesting monthly or quarterly thereafter. Performance-based vesting ties the vesting of options to the achievement of specific milestones, such as revenue targets or product launches.

Typical Outcomes for Unvested Options During Acquisition

When a company is acquired, the fate of unvested stock options is a primary concern for employees. Several common scenarios dictate their treatment, largely determined by the terms outlined in the acquisition agreement and the original option plan. Employees holding unvested options can experience a cash-out, conversion into acquiring company equity, acceleration of vesting, or forfeiture.

Cash-Out

A common outcome is a cash-out, where the unvested options are purchased for cash at the acquisition price. This typically involves deducting the option’s strike price from the per-share acquisition price, providing the employee with the intrinsic value of the options. This can result in an immediate payout, though sometimes a portion may be subject to a holdback or escrow.

Conversion

Another frequent scenario is the conversion of unvested options into equivalent options or shares in the acquiring company. In a stock-for-stock acquisition, the original options are exchanged for new equity in the acquiring entity, often at a predetermined conversion ratio based on relative stock prices. The original vesting schedule is typically maintained or adjusted, meaning the employee must continue to meet the vesting conditions with the new company to fully earn the replacement equity.

Acceleration of Vesting

Acceleration of vesting allows unvested options to become immediately exercisable sooner than their original schedule.

##### Single-Trigger Acceleration

Single-trigger acceleration occurs when the acquisition itself causes all unvested options to vest fully, providing an immediate payout or exercisable shares to the employee. This type of acceleration is less common for general employees and more frequently reserved for executives or key personnel.

##### Double-Trigger Acceleration

Double-trigger acceleration is a more prevalent form, requiring two distinct events for vesting to accelerate. The first trigger is the acquisition of the company. The second is a subsequent qualifying termination of the employee, such as an involuntary termination without cause or a resignation for good reason, often within a specified period post-acquisition. This mechanism protects employees in the event of job loss after an acquisition while incentivizing them to remain with the combined entity. If the employee continues employment without such a termination, the original vesting schedule typically remains in effect.

Forfeiture

Forfeiture is a less desirable, though possible, outcome for unvested options during an acquisition. This can occur if the acquisition price falls below the option’s strike price, rendering the options “underwater” and effectively worthless. In some cases, the terms of the original grant or the acquisition agreement may allow for the outright cancellation of unvested options, particularly if the acquiring company does not wish to assume them.

Key Determinants of Option Treatment

The specific treatment of unvested stock options during a company acquisition is shaped by several interconnected factors. Understanding these determinants is important for comprehending why certain outcomes occur.

Acquisition Agreement

The acquisition agreement, also known as the merger agreement, is the paramount document dictating the fate of equity awards. This legally binding contract between the acquiring company and the target company outlines the precise terms for all outstanding equity, including unvested stock options. It specifies whether options will be cashed out, converted, accelerated, or cancelled, and details any associated payout mechanisms or vesting adjustments.

Original Stock Option Plan and Grant Agreement

Complementing the acquisition agreement are the original stock option plan and the individual grant agreement provided to the employee. These documents contain clauses, often referred to as “change of control” provisions, that pre-define how options will be treated in the event of a merger or acquisition. These pre-existing terms may include provisions for acceleration or specific conversion ratios.

Type of Acquisition

The type of acquisition also influences the treatment of unvested options. In a stock purchase, where the acquiring company buys the shares of the target company, existing equity structures are often more likely to be assumed or converted. In contrast, an asset purchase, where only the assets and liabilities are acquired, may lead to the termination of existing option agreements unless explicitly assumed by the acquirer. The fundamental difference lies in whether the corporate entity, along with its existing equity, continues to exist.

Individual Negotiation

For most employees, the treatment of their unvested options is governed by the broad terms established in the company’s plans and the acquisition agreement. However, for certain key employees, particularly at executive levels, there may be opportunities for individual negotiation regarding their specific equity treatment. These individual agreements can sometimes include more favorable acceleration clauses or retention bonuses.

Employee Steps During an Acquisition

When a company announces an acquisition, employees with unvested stock options should take proactive steps to understand their specific situation.

Review Official Communications: Carefully review all official communications disseminated by both the acquired and acquiring companies. These communications often include detailed announcements, frequently asked questions (FAQs), and specific guidance regarding the impact on equity awards.
Review Original Documents: Locate and thoroughly review your original stock option plan documents and individual grant agreements. These documents contain critical clauses, particularly those related to a “change of control,” which outline pre-defined conditions for how unvested options might be treated during an acquisition.
Seek Clarification: Direct specific questions to your human resources department, legal counsel, or finance team. These departments are typically equipped to provide guidance on the company’s policies and the general implications of the acquisition on equity.
Consult a Tax Professional: Recognize that various tax implications exist for stock options, and these can vary significantly based on how unvested options are treated during an acquisition. A cash-out, conversion, or acceleration can each trigger different tax events and liabilities. Consult with a qualified tax professional to understand the specific tax consequences applicable to your individual circumstances.