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M&A: Basics

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My Company Is Being Acquired: What Happens To My Stock Options? (Part 1)

Richard Lintermans
Editor's Note: For the treatment of restricted stock and RSUs in M&A, see the FAQs on the impact and taxes. Another FAQ covers performance shares.

Your company is being acquired. You worry about losing your job and your valuable stock options. What happens to your options depends on the terms of your options, the deal's terms, and the valuation of your company's stock. Part 1 of this series examines the importance of your options' terms.

The Terms Of Your Options

Your options are generally secure; but not always.

Your stock option provisions appear in at least two places: (1) in the individual grant agreement, and (2) in the plan. You received both with your option grant package. The terms that apply to mergers and acquisitions are usually found in the sections concerning "change in control" or "qualifying events." Depending on the company’s practices and the flexibility it has in the plan, individual grant agreements can have specific terms on acquisitions that either mimic or are more detailed than the terms of the plan document under which the grant is made, or they can just cross-reference the plan.

Vested Options

Your options are generally secure, but not always. The agreements constitute contractual rights you have with your employer. Your company cannot unilaterally terminate vested options, unless the plan allows it to cancel all outstanding options (both unvested and vested) upon a change in control. In this situation, your company may repurchase the vested options.

The focus of concern is on what happens to your unvested options.

When your company (the "Target") merges into the buyer under state law, which is the usual acquisition form, it inherits the Target's contractual obligations. Those obligations include vested options. Therefore, your vested options should remain intact in a merger/reorganization scenario. Check the agreements to be sure, though.

In an asset acquisition, the buyer purchases the assets of your company, rather than its stock. In this situation, which is more common in smaller and pre-IPO deals, your rights under the agreements do not transfer to the buyer. Your company as a legal entity will eventually liquidate, distributing any property (e.g. cash). Look at what your company received in exchange for its assets and at any liquidation preferences that the preferred stock investors (e.g. venture capital firms) have in order to determine what you may receive for your vested options.

Unvested Options

The focus of concern is on what happens to your unvested options. Some plans provide latitude to your company's board of directors (or its designated committee) to determine the specifics of any acceleration of unvested options. The agreements may provide the board with absolute discretion as to whether to accelerate the vesting at all. Alternatively, the stock plan documents may require acceleration.

In its 2013 Domestic Stock Plan Design Survey, the National Association of Stock Plan Professionals (NASPP) received the following data from responding companies about their treatment of stock grants in changes of control.

Treatment Options/SARs Restricted stock/RSUs Performance awards
Vesting accelerates on all unvested awards

Automatically: 84%
At board's discretion: 34%

Automatically: 82%
At board's discretion: 35%

Automatically: 69%
At board's discretion: 35%

Vesting accelerates on some unvested awards (pro rata payout)

Automatically: 3%
At board's discretion: 15%

Automatically: 5%
At board's discretion: 15%

Automatically: 15%
At board's discretion: 20%

Vested awards only are paid in cash

Automatically: 2%
At board's discretion: 16%

Automatically: 3%
At board's discretion: 16%

Automatically: 3%
At board's discretion: 13%

Vested and unvested awards are paid in cash

Automatically: 7%
At board's discretion: 16%

Automatically: 7%
At board's discretion: 16%

Automatically: 9%
At board's discretion: 15%

Awards are canceled

Automatically: 1%
At board's discretion: 13%

Automatically: 2%
At board's discretion: 12%

Automatically: 1%
At board's discretion: 12%

Other

Automatically: 2%
At board's discretion: 7%

Automatically: 2%
At board's discretion: 7%

Automatically: 4%
At board's discretion: 6%

Acceleration Events

The triggers for acceleration usually involve a numerical threshold. The agreements or the board may provide that any of the following (or other) events constitute an acceleration event:

  • More than 50% of the board seats change, and those changes were not supported by the current board (i.e. a hostile takeover); or
  • Purchase of at least 40% of the voting stock of the company by any individual, entity, or group; or
  • Approval by the shareholders of a merger, reorganization, or consolidation if more than 60% of the company will now be owned by what were previously non-shareholders (i.e. an acquisition by another corporation); or
  • Approval by the shareholders of a 60% or more liquidation or dissolution of the company; or
  • Approval by the shareholders of a sale of assets comprising at least 60% of the business.

Under some plans, a combination of events may be required for an acceleration of vesting to occur, such as the combination of a demotion or termination without cause and a merger. The amount of acceleration may vary depending on a combination of criteria. For example, you may receive a 25% acceleration upon a change in control, but that acceleration may go up to 75% if you are terminated without cause as a result of the change in control.

Mechanics Of Acceleration

Acceleration generally takes one of two forms:

  • All of your unvested options vest immediately; or
  • A portion of your unvested options accelerates (partial acceleration).

When plans partially accelerate options, the provisions vary greatly. The acceleration can be based on time. For example, options that would have otherwise vested over the next 12 months can become immediately exercisable, or an additional 10% of your options can become vested for each one year of service to the company.

When you have a graded vesting schedule, another common method is to accelerate your vested percentage by the same amount in which you are already vested. For example, if you are 50% vested at the time of the change in control, then 50% of the unvested options would accelerate, so you would be 75% vested immediately thereafter.

Downside Of Acceleration

You may believe that accelerated vesting mandated by your agreement is a pro-employee feature of your stock plan. However, it can be a constraint.

A buyer may be interested in acquiring your company, but the provisions in the option agreements may make your company a less attractive target. You may believe that accelerated vesting mandated by your agreement is a pro-employee feature of your stock plan. However, it can be a constraint, affecting how a deal is structured, as well as the costs to your company and the buyer. It can even cause the deal not to happen at all.

Buyers are concerned, for example, that accelerated vesting could cause valuable employees to leave after they cash-in from all their options right after the closing. Thus, options can lose their power as a retention tool. When agreements provide latitude to the board, or are silent, the strategic position of your company in negotiating with the acquiring company over the terms of the sale will often drive the terms of acceleration.

Timing Of Acceleration

Acceleration most commonly occurs at the moment just prior to the merger or "qualifying event."

The actual date of acceleration is generally the effective date of the merger or "qualifying event," which likely requires shareholder approval. Acceleration most commonly occurs at the moment just prior to the merger or "qualifying event."

The unvested options usually are not accelerated earlier than the date of closing in case the deal does not go through. Should the deal not close, your options will not be accelerated. Check your plan documents for guidance on the timing. When not specified, the timing of acceleration is at the board’s discretion.

ISO Acceleration Trap

Among the requirements for options to be ISOs, which are detailed in the FAQs on this website, is the rule that not more than $100,000 worth of ISOs can be "first exercisable" (i.e. available to be exercised for the first time) in any one year. The calculation for this limit is based on the value of the underlying stock when the options are initially granted. When acceleration of vesting due to a change in control causes more ISOs to vest in a single year, this can cause all of the newly vested options with a combined grant value over $100,000 to be NQSOs.

Acceleration of ISO vesting can cause some ISOs to become NQSOs.

For example, if you originally had expected to vest $50,000 worth of ISOs this year, but because of an acceleration in vesting, you can now exercise $150,000 worth of ISOs for the first time this year, the newest $50,000 worth of the vesting stock options will convert to NQSOs if you do so.

You cannot cherry-pick which options become NQSOs. The order of conversion from ISO to NQSO in a multi-grant scenario (where the $100,000 limit is exceeded) is based on the age of the grant. The youngest grants are converted first. The earliest grants are accorded ISO treatment.

Golden Parachutes

Although it's beyond the scope of this website, the acceleration of vesting may also cause problems under the IRS "golden parachute" rules for highly compensated executives or employees. If you are concerned that you may fall into this group, see a related FAQ and check with your employer. If your employer doesn't know the answer or informs you that you do fall into this category, seek professional tax advice.

Next Articles

Part 2 of this series will address how the terms of the deal and the valuation of your company affect your stock options. Part 3 will cover the tax treatment.

Richard Lintermans is now the tax manager in the Office of the Treasury at Princeton University. When he wrote these articles, he was a director at the tax-only advisory firm WTAS in Seattle. This article was published solely for its content and quality. Neither the author nor his former firm compensated us in exchange for its publication.

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