As a financial advisor, I have dealt with dozens of liquidity events — whether that’s an initial public offering (IPO), a secondary sale, or an acquisition. Personally, my favorite type of liquidity event is an acquisition because it removes the tyranny of choice from the employee holding shares in the company, also known as employee stock options or ESOs. With an IPO, so many choices exist, and with a volatile stock price, employees are thrust into the emotional rollercoaster of deciding when to sell. With an acquisition, the price is fixed, and typically, cash is exchanged for existing shares and vested options. In most cases, unvested shares are paid out or forfeited altogether.
When an acquisition occurs, there are various things that can happen depending on the current status of your stock options. You may be wondering: should I exercise my options before the acquisition?
The short answer is: it depends. Every situation is unique. But let’s assume you’re interested in seeing how the acquisition plays out before selling, or don’t have the ability to exercise your options. We’ll explore these scenarios below.
These are typically paid out in cash at the share price related to the acquisition deal. If you’ve held those shares for more than one year, you could pay the lower capital gains tax rate. Sometimes, shares are converted to the acquiring company’s stock, but this is typically not an ideal outcome for employees who just wanted to enjoy their liquidity event.
This is where it gets interesting. Sometimes, vested stock options are treated like shares and typically paid out net of your strike price. When the stock is paid out net of your strike price, it means that the strike price is subtracted from the value of your stock when you exercise the option. The resulting amount is what you actually receive as a payout. Other times, there’s a brief window to exercise the options before the transaction closes and the shares are then converted to the acquiring company’s stock.
This depends on how the acquisition deal is structured and how the company favors its employees. Typically, new grants are issued for unvested options in the acquiring company’s stock. For many employees, the best-case scenario is a full cash-out where the unvested options are exchanged for cash, but not always paid in one lump. Unfortunately, in the worst-case scenario, the grants are canceled after the acquisition date, and there’s nothing the employees can do about it.
In my experience as a financial advisor, I’ve seen some generous scenarios where the acquired company negotiated for all vested and unvested stock options to be paid out in cash at the time of acquisition, but with an escrow agreement where the employee has to stay at the new company for a certain time period — typically a year or two.
Company acquisitions often come as a surprise to employees, so the best thing you can do is understand what you own and make a plan for how you might handle a liquidity event. This is where working with a financial advisor to plan ahead can come in handy.
Your personalized financial plan might include using a certain amount of cash from an acquisition to pay off loans or buy a home. FinanceHQ’s network of financial advisors specializes in helping clients navigate investment opportunities that come with equity compensation. Get matched with a financial advisor today to stay ahead of the game.
AJ Ayers, CFP®, EA, CEP, is the co-founder of Brooklyn FI (BKFi), residing in Brooklyn, New York.