What happens to stock when a company is bought out or acquired?
If you have stock options, RSUs, or another type of equity compensation, you’ll want to know what could happen when a company is bought. What happens to stock options or restricted stock units after a merger or a company is acquired? The type of equity and whether your grant is vested or unvested are main factors. Here are a few possible outcomes for stock options after a merger, acquisition, or sale of a company.
The type of equity impacts the treatment of stock after a company is bought out
What happens to your stock after an acquisition depends (in part) on what type of equity compensation you have. There are many different types of equity plans a company can use to incentivize staff. It is also not uncommon for employees to receive multiple different types of equity-based compensation at once.
Stock option plans options typically include incentive stock options or nonqualified stock options, where employees must actually purchase the shares with cash or exercise their options and immediately sell enough shares to cover the cost of the purchase, otherwise known as a cashless exercise or a sell-to-cover.
What happens to these forms of stock compensation following an acquisition? Unfortunately, the answer is going to be specific to the deal and likely rather complicated. Other factors that matter include the terms of the deal (cash vs stock buy out) and how the purchase price impacts the value of the shares. Another factor? The value of the acquiring company’s stock relative to the company being acquired.
You won’t know what will happen to your stock until the sale is final
In all likelihood, if you work for a public company, there will be considerable lag time between when you first learn of the deal and when it’s approved by shareholders, perhaps regulatory agencies, and then finally completed. Until the terms of the merger or acquisition are finalized, employees won’t have answers to the lingering questions about what will happen to their stock compensation.
Once the guidance is released, it may still take more time to work through what exactly it means for you. Particularly if you have multiple forms of equity compensation with different vesting schedules, strike prices, etc., it will take time to get through the legalese.
Even with the terms of the buyout, you may still have to wait until the deal is final to calculate your potential payout, if the stock prices in the days or weeks before the close play a role in the calculation. As you wait, try to address some of the other personal financial challenges associated with M&A activity.
Vested vs unvested shares in a merger, acquisition, or sale
Stock options and RSUs are either vested or unvested. When you receive a grant, there will typically be a vesting schedule attached. This document outlines how long you have to wait before you can exercise stock options to buy the shares, or in the case of restricted stock units and equity awards, are given shares or cash.
Restricted stock units (RSUs) and restricted stock awards almost always settle in shares or cash upon vesting. So if you still have either type of equity, you’re probably unvested.
For option-holders or individuals with stock appreciation rights, once vested, you might be able to exercise any ‘in-the-money’ options/awards. Often, by the time employees get wind of a buyout, restrictions are already in place preventing public or private company employees from exercising stock options.
If your shares are unvested, you haven’t yet earned the shares, at least not under the original ‘pre-deal’ vesting schedule. Whether your options are vested or unvested will in part determine what happens to the stock granted by your employer.
Vested stock options when a company is bought out
Vested shares means you’ve earned the right to buy the shares or receive cash compensation in lieu of shares. Typically, the acquiring company or your current employer handles vested stock in one of three ways:
1. Cash out your options or awards
The actual amount you could receive will likely depend on your current exercise/strike price, the new price per share, or any other payment terms negotiated by the firms. 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.
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.
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2. Assume or substitute your stock options
The new company could also assume the value of your vested options/awards or substitute them with their own stock. Both ways should allow you to continue to hold equity awards or opt to exercise.
3. Cancel underwater vested grants
Certain types of equity compensation can become ‘underwater,’ meaning the current market value is less than the strike or exercise price. The exercise or strike price is what you’d pay to buy the stock or exercise your award. Incentive stock options, stock appreciation rights, and non-qualified stock options are common examples.
If your grant is underwater, the acquiring company may not want to be so generous, 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.
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.
What happens to unvested stock options or RSUs in an acquisition?
Investors with unvested stock options or RSUs are in a more difficult position. In general, there are three common outcomes for unvested stock options:
1. Cancel unvested grants (underwater or not)
With unvested stock, since you haven’t officially “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 may be hard to tell whether your vested or unvested grant would 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 pay out.
2. Accelerate your vesting, partially or in full
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.
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 new company 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 new company could 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 retain your unvested shares.
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.
Darrow Wealth Management is a financial advisor for employees with stock options and RSUs
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. The above 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 contact us or schedule a phone consultation today.
(Note: 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. Darrow Wealth Management does not provide tax or legal advice; for inquiries regarding your personal tax or employment situation, consult a CPA or employment attorney in your area.)