If your company (e.g. the target company) is getting acquired, you’ll want to understand what happens to your stock. When a company buys another company, what can happen to your stock depends on several factors, including if you own stock outright or vested/unvested stock options/RSUs. Here’s more on what happens to employees with equity after a merger, acquisition, or sale of a company.
What happens to my stock in an acquisition?
Cash vs stock buyouts (e.g. terms of the deal). A key factor in determining what happens to employees with stock during an acquisition is whether the company is bought out in an all-cash deal, all-stock, or a combination.
In a cash deal, eligible employees (more below) generally just get paid out in exchange for their shares or options. With any type of stock deal, employees could receive stock of the acquirer in a stock-for-stock exchange, cash, or both.
Do you own shares outright or through equity awards and stock compensation?
In a merger or acquisition, employees with equity compensation will fall into one or more of the categories below:
- Stockholders (exercised vested options, retained vested RSUs, ESPP shares, founders shares, direct purchases, etc.). Stockholders often get the best treatment because their ownership rights aren’t up for debate. They own equity in the target company.
- Employees with equity compensation
- Vested, unexercised stock options (incentive or nonqualified stock options)
- Unvested stock options
- Restricted stock units (RSUs)
Often, employees fall into both categories.
Shareholders: here’s what happens to stock when a company is bought
For shareholders (own stock outright) what happens to the shares they own when the company gets bought out is more straightforward. In a cash purchase, it’s a cash payout. In a stock deal, shareholders get stock of the acquiring company. Depending on the deal terms, they may get both.
For employees with equity compensation, a lot can happen. This is the focus of this article.
What happens if you have stock options when a company is acquired
For employees who have stock options, an acquisition can work out a few different ways. The primary consideration is whether your shares are vested or unvested (including restricted stock units).
Vested stock options when a company is bought out
Vested shares mean you’ve earned the right to buy the shares or receive cash instead of stock – assuming your options are still worth something.
So what happens to your vested stock options when a company is bought? Typically, when a company is bought out, the buyer will either:
- Cash out vested stock options
- Substitute the target company’s grant with shares of the acquiring company’s stock
- Cancel the grant.
1. Cash in exchange for your shares
Again, refer to the terms of the deal! When a company is bought out with cash, shareholders generally get cash in exchange for their stock. The actual amount you will likely depend on your strike price, the closing price per share, or any other payment terms negotiated in the buyout.
But the effect will be the same: to liquidate your equity position.
Planning note: If you have vested incentive stock options, you’ll want to consider the pros and cons of exercising before the deal closes. When unexercised ISOs are cashed out at closing, it’s considered a cancellation of stock options for tax purposes, not a disqualifying disposition. This is important, as the former will be subject to payroll tax. Exercising shortly before the deal closes can prevent this from happening. Public company employees are often subject to blackout periods and lockups at some point during M&A activity, so make sure you stay in compliance.
When Should You Exercise Stock Options?
2. Assume or substitute your stock options
In a stock-for-stock acquisition, the acquiring company could also assume the value of your vested options or substitute them with their own stock. Substitution is more common as the acquirer will only assume equity compensation if they plan to keep the target company as its own independent business.
Both ways should allow you more time to exercise your options. If stock is substituted, when the deal closes, there will be a conversion or exchange ratio based on the relative stock prices. That will determine the number of options you have.
3. Cancel underwater vested grants
Regardless of the deal terms, there’s still a risk that vested stock options could get cancelled in an acquisition or sale. Incentive and nonqualified stock options can become ‘underwater,’ meaning the current market price (or deal price) is less than the strike or exercise price (your cost to buy the stock).
If your grant is underwater, the acquiring company may cancel it, as even vested shares are technically worthless. Employees may be given a nominal payment by the acquiring firm in exchange for cancelling the stock grant. Restricted stock units can’t go underwater since they are given to employees and only have value at vesting (and at vesting RSUs turn into shares or cash).
Depending on your equity holdings, your grants might not all receive the same treatment. Meaning, some of your vested grants may be cashed out and others cancelled.
Stock Option and Equity Compensation Advisors
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Should you exercise before the deal closes?
The downside is that the deal may not close. Or if delayed, holding incentive stock options through the end of the year can trigger the alternative minimum tax (AMT). Should the deal not go through, you may be left with a large tax bill and no liquidity to pay it. Speak with your financial and tax advisor before making a decision.
What happens to unvested stock options or RSUs in an acquisition?
Executives with unvested stock options or RSUs are in a more difficult position as they haven’t yet earned the shares.
Does acquisition make stock options vest?
Yes, in the best-case scenario after an acquisition, vesting is accelerated, and your unvested shares are treated just like regular shareholders.
Here are three possible outcomes for unvested stock and RSUs when a company is acquired:
- Cancel unvested grants
- Accelerate vesting schedules
- Substitute, assume, or cash out unvested shares
1. Cancel unvested grants (underwater or not)
With unvested stock, since you haven’t “earned” the shares, the acquiring company could potentially cancel the outstanding unvested grants. Some common financial reasons include concerns about diluting existing shareholders or the company couldn’t raise enough cash through new debt issues to accelerate unvested grants.
Depending on your strike price, it can be hard to tell if your vested or unvested grant will be underwater when the acquisition is complete, depending on the shareholder payout or other specific terms indicated in the agreement. Unvested stock options that are underwater are at the most risk of being cancelled without a payout.
This is more likely in a scenario where the acquiring company intends to eliminate a lot of jobs held by target company workers. Stock compensation is used to retain employees, so if the company doesn’t have a desire to do that, they don’t have much incentive to keep worthless stock grants.
2. Accelerate vesting
The acquiring company can also accelerate the vesting of options or awards, choosing to pay cash or shares in exchange for the cancellation of outstanding grants. Acceleration of vesting may not be available uniformly across equity types or grants. The acquiring company may also attach a vesting schedule to cash payouts to improve retention.
For example, the terms may provide a new vesting schedule, where unvested grants will receive accelerated vesting based on the original schedule if the deal hadn’t happened. The acquiring company could cancel grants that wouldn’t have vested for a while, with or without compensation. The acquirer could also partially vest shares or continue the stock plan.
This type of arrangement could apply universally to all employee stock offered in the incentive plan, or only to certain types.
Planning note: If you have incentive stock options, accelerated vesting could mean exceeding the $100,000 annual limit for ISOs. The value is based on the fair market value at grant. Any amount in excess of $100,000 will be treated as a non-qualified stock option. Speak with your financial and tax advisor to discuss your situation.
3. Assume, substitute, or cash out unvested options
The acquiring company can assume your current unvested stock options or RSUs or substitute them. The same goes for vested options. You’d likely still have to wait to buy shares or receive cash, but could at least keep unvested shares.
For example, in the Takeda acquisition of Shire, awards were converted on a predetermined valuation outlined in the terms of the deal. Shares were paid out in cash according to the original vesting schedule, as long as the employee stayed with the company.
If the acquiring company is private but has plans for an IPO, additional planning opportunities may be available to you. More on what can happen to stock options after an IPO here.
M&A tax implications for employees
A lot can happen during M&A so be sure to discuss your situation with your tax and financial advisor. Often, the regular tax implications for nonqualified stock options and incentive stock options will apply to stock/options when a company is sold. Similarly, equity awards (restricted stock units) will still be taxed as ordinary income at vesting when stock (or cash) is received.
Typically, if equity is assumed or substituted by the acquiring company, there are no immediate tax implications. But again there are nuances, so consult a tax advisor to discuss your situation.
Stock option advisors
What will happen to your stock options or equity compensation depends on how the firms structure the deal. As you can see, there are complex financial, legal, and retention issues at play. This article is a simplified summary and not an exhaustive discussion of what could happen to shares following an acquisition, including potential planning opportunities and tax implications.
Since there are many different types of potential outcomes and considerations for professionals when a company is sold, it’s important to review your specific situation with a financial advisor. To discuss your personal situation, please schedule a phone consultation today.
Nationally Recognized Wealth Advisor in Stock Compensation
Selection of media appearances by Kristin McKenna CFP®, President of Darrow Wealth Management and a nationally recognized specialist in employee stock options and equity compensation.
Publications above reflect media organizations that have quoted and/or published articles authored by Kristin McKenna and should not be misconstrued as a current or past endorsement of Kristin McKenna, Darrow Wealth Management, or any of its advisors. Please refer to the media page for more information and links to published works.
Darrow Wealth Management offers Private Wealth and Asset Management to individuals and families. This article is not a substitute for personalized tax or legal advice from a CPA, tax advisor, or attorney.
Last reviewed October 2024
