When a startup is acquired, the unused part of the option pool is cancelled, and its value goes to the stockholders. The merger agreement decides what happens to options already granted. Vested options are usually cashed out at the deal price minus the exercise price. Unvested options are either taken over by the buyer on the same vesting schedule, turned into retention payments, or cancelled, depending on the plan and the deal.
Key takeaways
- Nobody gets paid for unallocated pool shares. They’re cancelled at closing.
- Vested options are usually cashed out for the “spread,” meaning the per-share deal price minus the exercise price.
- Unvested options are taken over by the buyer, paid out over time, or cancelled. The plan and the merger agreement decide which.
- Employees get acceleration only if their grant or the plan provides it. Double trigger is the standard.
What happens to the unallocated pool?
It’s cancelled. Shares that were reserved for future grants but never granted don’t count when the deal price is divided up, so their value goes to the stockholders and to holders of granted options. The buyer may set up its own retention grants instead.
What happens to vested options?
Usually the buyer cashes them out. Each option is paid the per-share deal price minus its exercise price, and the employee never has to exercise. For employees, the payment is taxed as wages and paid through payroll, so employees should talk to a tax advisor. If the exercise price is higher than the deal price, the option is “underwater” and is usually cancelled with no payment. Some deals let employees exercise before closing instead, and they then get paid as stockholders.
What happens to unvested options?
There are three common outcomes:
- Assumed or substituted. The buyer converts them into options on its own stock, with the same vesting schedule. To keep the employee’s spread the same, the number of shares is multiplied, and the exercise price divided, by an exchange ratio: the deal price per target share divided by the buyer’s share price.
- Cashed out over time. The spread is paid as the options would have vested, as long as the employee stays. This is common when the buyer is private or doesn’t want to issue its own equity.
- Cancelled. If the buyer doesn’t take them over, most option plans let the board cancel unvested options. In practice, buyers that want to keep the team usually offer new grants or retention bonuses instead, and employees get notice before anything is cancelled.
The board picks among these when it approves the deal, within what the plan allows.
Do employees get acceleration?
Only if their grant, the plan or their employment agreement says so. Founders and executives commonly have double-trigger acceleration: unvested options vest if the person is let go without cause, or quits for good reason, within about 12 months after closing. Most other employees have none. See Single Trigger vs Double Trigger Acceleration.
How is the price per share calculated?
The buyer’s price for the equity goes first to any liquidation preferences, and the rest is divided among the stockholders and granted options. Options are counted net of their exercise price.
Example: A buyer pays $50 million for the equity. The company has 9 million shares outstanding (with preferred counted as converted to common), 1 million granted options with a $1 exercise price, and 1 million unallocated pool shares.
- Per-share price: ($50 million + $1 million total exercise price) ÷ (9 million shares + 1 million options) = $5.10
- Stockholders receive $45.9 million. Option holders receive $4.10 per option, or $4.1 million in total.
- The 1 million unallocated shares get nothing. If they were counted, the per-share price would drop to about $4.64.
If investors’ liquidation preference would pay them more than converting to common, that amount comes off the top first. Escrows and holdbacks usually reduce what every holder gets at closing. See Liquidation Preference.
What should founders negotiate for employees?
- That the buyer takes over unvested options or replaces them with equity of equal value, rather than cancelling them.
- How underwater options are treated.
- Whether a retention pool for key employees comes out of the purchase price, which reduces what stockholders receive.
- When option payments are made, and whether escrow and earnout payments apply to option holders the same way they apply to stockholders.
- Double-trigger acceleration in grants well before any sale, because it’s hard to add during a deal.
Related: The 3 Types of Startup Acquisitions · Single Trigger vs Double Trigger Acceleration · Liquidation Preference · Drag-Along Rights · Employee Stock Option Plan (ESOP)
