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Vested and Unvested: Demystifying Stock Option Outcomes in Mergers and Acquisitions

Vested and Unvested: Demystifying Stock Option Outcomes in Mergers and Acquisitions

January 05, 2024

Are you currently experiencing a company takeover, or are you curious about the implications for your stock options in the event of an acquisition? You’re not alone. The uncertainties following an acquisition can make even the most composed employees anxious about their stock options. Here is what you need to know concerning acquisitions and the fate of your stock options.

Know Your Stock Options Terms

The terms in your grant agreement and the overall plan determine what happens to your stock options after an acquisition. Pay particular attention to the "change in control" or "qualifying event" bit of these documents to understand how your options might change.

The Fate of Vested Options

Your vested options stay safe because the acquiring company gets them, along with other contractual commitments, in a merger or reorganization. Vested options typically enjoy a degree of security. These options are contractual rights, and your company cannot unilaterally terminate them, except in cases where the plan allows the cancellation of all options following a change in control.

In an asset acquisition, where the buyer acquires your company's assets instead of its stock (common in smaller or pre-IPO deals), your rights do not transfer to the buyer. Your company will eventually close, distributing assets like cash. Check what your company received for its assets and preferences among preferred stock investors, such as venture capital firms, to know what you might get for your vested options.

The Fate of Unvested Options

The crux of the matter lies with unvested options during an acquisition. Unvested options may undergo acceleration, allowing employees to gain quicker access to the benefits of their stock options. Some plans grant flexibility to your company's board of directors or a designated committee for deciding the specifics of unvested options acceleration. The agreements might give the board absolute discretion, or the stock plan documents could mandate acceleration.

Acceleration Events

Acceleration events are particular triggers that speed up the vesting of unvested stock options. These events hinge on specific numerical thresholds. They include:

  • A hostile takeover triggered by a 50% change in the company board seats
  • A 40% acquisition of company stock by an individual, entity, or group
  • Shareholder approval exceeding 60% for an acquisition by non-shareholders
  • Shareholder approval surpassing 60% for company liquidation, dissolution, and a company asset sale

Events can either speed things up on their own (single triggers) or require a combination of two events (double triggers). The acceleration percentages in double triggers vary based on certain criteria. For example, a change in control might accelerate your stock options by 25%. However, if your employment abruptly ends without cause due to the change in control, the acceleration could increase to 75%.

The 2021 Equity Incentives Design Survey by the National Association of Stock Plan Professionals (NASPP) reveals that 66% of companies opted for the double trigger treatment in changes of control for stock grants. In contrast, 18% chose the single trigger, 9% had no acceleration, and 7% left the treatment decision to the discretion of the board or compensation committee.

Forms of Acceleration

Acceleration manifests in two forms. It can be immediate vesting, where all unvested options swiftly become fully vested, or partial acceleration, where only a portion of unvested options accelerates, enabling a more gradual vesting process.

Companies can use various ways to accelerate options. One way is based on time, making options immediately usable instead of waiting. The option enables you to utilize options set to fully vest in the next 12 months immediately. Another way is to increase vested options by the same percentage already vested during a change in control. Thus, an additional 10% of your options can become fully vested for each year of service.

Another acceleration option exists if you follow a graded vesting schedule. Your company can increase the percentage of options that become fully yours by the same amount you’re already vested. For instance, if you’re 50% vested during a change in control, 50% of unvested options become fully yours, making you 75% vested immediately.

Drawbacks in Acceleration

Unfortunately, stock acceleration has one downside. Buyers worry that speeding up vesting could push key employees to exit post-closure, diminishing options' effectiveness as retention incentives. When agreements are flexible, your company's negotiating stance with the buyer shapes the acceleration terms.

When Acceleration Takes Place

Acceleration typically coincides with the acquisition or qualifying event following shareholder approval. Unvested options only accelerate on the closing date of the acquisition, preventing premature advancement if the deal fails. If the deal falls through, your options will not speed up. Check your plan documents for timing details. If not specified, the board decides when acceleration occurs.

ISO Acceleration Trap

A tax issue may arise when a company faces a change in control, causing a surge inIncentive Stock Options (ISOs) vesting in a single year. The IRS caps ISOs exercisable in a year at $100,000. Excess options automatically turn into less tax-favored Non-Qualified Stock Options (NQSOs) if accelerated vesting surpasses this limit due to a change in control. Conversion is based on grant age, starting with the youngest. Thissituation can lead to unexpected tax implications, so stay informed if you have ISOs and your company undergoes a change in control.

Golden Parachutes

Executives receive substantial severance packages, known as golden parachutes, when a change in control, such as a merger or acquisition, occurs. IRS rules restrict tax benefits for highly compensated individuals. Tax advantages may diminish or vanish if the parachute's value exceeds a set limit.

Seek advice from a tax advisor with expertise in executive compensation for a thorough analysis and guidance on potential tax implications.