Today’s article is one I have had a few people ask about. The topic specifically is what the heck happens to my Equity Compensation when or if my company is bought out. I will also touch on what happens to it if the company goes completely under, but that is a short explanation and we won’t start there as it is not good news.
How about we first talk about Non-Qualified Stock Options, also known as Options. This needs to be broken into two main categories. What happens with those Options that are already vested and, you guessed it, those that are not yet vested.
For vested options, your options should be secure, but it is not guaranteed. You will need to check your plan documents and agreements to confirm the language on what happens if your company merges. This is a reason I always harp on maintaining those documents. These agreements are contractual rights you should be able to maintain. But again, the devil is in the details of the document itself.
The typical result is your company is acquired by another and you merge into the company that acquired yours. Assuming the agreement language is solid, the new company has to honor your options which are already vested.
I will briefly mention what happens when it isn’t a merger, but instead is when a new company acquires the assets of your company. I won’t spend much time here because this typically happens in pre-IPO companies and I don’t cater to this world. The short version is the acquirer is taking the assets of the smaller company but not the stock. In these situations it really depends on the acquisition language and you will need to check with your employer.
Let’s jump over to what happens if your Options are not yet vested. The word of the day boys and girls, is acceleration. Acceleration in this case is simply whether your unvested options will vest sooner or even immediately. Again, the specifics depend on the plan documents and also the merger language.
However, the basics of acceleration are just that – basic. All of your unvested options may accelerate immediately. Or it may be a situation where there is a partial acceleration. This is like it sounds. Some of the unvested options now vest, but not all of them.
Now that we have covered this general background based on the wording of your stock options agreements, I wanted to cover a few more specifics of what happens to your options in the deal, both vested and unvested. And these specifics are all dependent upon the terms of the deal and how it is actually structured. So, this is a case-by-case basis.
Again, we start with vested options. The merger terms will dictate what happens with these options that have already vested. First possibility is the vested options transfer proportionally into your new company’s stock. You know, maybe you get two shares of the new company stock for every share of the old company stock you owned. Another possibility is they cash out your stock options. Yes, this means they just give you cash for them. Technically the options are canceled, but you walk away with some cash. And in some situations, nothing happens. That’s right, you get to keep your stock options. This occurs if your old company is simply something like a subsidiary of the new parent company.
For unvested options, the future is less clear in a merger or acquired. Your unvested options could be canceled. They could also be cashed out. Another possibility is they could be replaced with unvested options of the new company, but I wouldn’t expect them to be at the same level. So, the lesson here is hopefully the terms of your stock options say anything not yet vested will fully vest if your company is acquired.
I now want to spend a few minutes talking about what happens with Restricted Stock Units, known as RSUs. The comments I share will sound familiar to what we already covered with Non-Qualified Stock Options.
Just like with the options, let’s first tackle those RSUs that have already vested. As a reminder, with RSUs, once they vest you fully own the company shares that were awarded as part of your grant of RSUs. In this case, you are looking at the terms of the deal. Simply, you are treated like any other shareholder. It may be a situation where you get one share in the new company for every share you own or maybe some other factor like a one for two.
Unvested RSUs is where it gets more complicated. How about we start with a couple of simple possibilities. The better possibility is you receive some cash for the unvested RSU. You may not get the full value, but you get something. This is because another possibility is the unvested RSUs are simply canceled. You guessed it – you get nothing.
On a slightly brighter side, let’s talk about some other possibilities with unvested RSUs. One involves acceleration. Yes, those unvested RSUs will vest sooner than planned. Another option is your unvested RSUs are exchanged for RSUs with the new company, but they are still not yet vested. In these two options you still have RSUs, which hopefully is better than being cashed out and definitely better than being canceled.
I will mention taxes quickly. Please don’t rely on this to be gospel as I am not going into it in great detail. Plus, you always need to consult with your tax advisor on what happens in cases of a merger.
For Restricted Stock Units, if your unvested shares are cashed out this is a fully taxable event. So, it will show up as ordinary income like you sold the shares. Speaking of selling shares, if your vested RSUs from the old company are sold to buy shares of the new company, this also is a taxable event. Fortunately, it is treated as capital gains.
A common event is RSUs are exchanged from the old company to the new one. Here, again, it depends on the terms of the deal and how taxes apply for exchanged shares. One possibility is a tax-free swap. For a swap, your holding period and basis are carried over, which is a nice deal in my mind. If it isn’t a tax-free swap, you will owe capital gains and the basis will be reset.
When it comes to the tax treatment for Non-Qualified Stock Options, I am going to wimp out. The details here get super complex quickly. Ultimately, it really comes down to how the deal is structured. You may get options, or stock, or cash, or some combination. Which direction determines the tax consequence and there are just too may directions to cover in this article.
This seems like a good place to wrap up what happens in those cases when you company is bought out. Oh wait, I promised to mention what would happen if your company goes completely under. Again, depends on the specifics of does it go completely out of business or is it just modified under bankruptcy. The latter situations are more dependent on the specifics of bankruptcy. However, in the former case it is pretty straightforward. If your company goes completely under and out of business, you get nothing.
Again, seems like a good place to stop here on what happens when your company is bought out. It is critical for you to refer to the option and RSU agreements your employer gave you that I know you have kept in a safe place for years. It is also important to know what happens under the terms of the merger or acquisition. This is definitely one of those situations where you can’t be shy. I simply mean you need to be asking questions to find out how it impacts you. As always, if I can be of help do not hesitate to reach out at any point. Via email to email@example.com or visit my website forwardthinkingwm.com to schedule a quick call.
I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.