The treatment of the option pool is an important term in an acquisition negotiation. This article will help founders and employees better understand how the option pool is handled at acquisition.
Treatment of the Option Pool in an Acquisition
The treatment of the option pool in an acquisition depends on the terms of the deal. The acquiring company may take on the existing option plan or replace it with their own. If the existing plan is taken on, all outstanding options will continue to vest and be exercisable on their original terms. If replaced, outstanding options may be converted into new options based on a conversion ratio.
It is important for employees to understand how their options will be treated during an acquisition to make informed decisions about whether to exercise them. A change of control provision in a stock option agreement may allow employees to accelerate the vesting of their options upon a change of control event. This should be reviewed carefully by employees and companies when negotiating employment agreements and planning for potential exits.
Replacing the Existing Option Pool with a New Equity Compensation Plan
In some cases, the acquiring company may replace the existing option pool with their own equity compensation plan. This can happen for several reasons, such as differences in the size or structure of the two companies’ workforces or a desire to align incentive structures across all employees.
If this happens, outstanding options held by employees under the old plan will typically convert into new options under the acquiring company’s plan. The conversion ratio is usually determined by dividing the strike price of the old options by that of the new options.
It’s important for employees to understand how their options will be affected if the acquiring company replaces the existing option plan. They should review their stock option agreement and any other relevant documents carefully to determine their rights and how to exercise them.
For startups, it’s important to consider how an acquiring company’s equity compensation plan might impact employee retention during an acquisition. Startups should work closely with legal and financial advisors to negotiate favorable terms for themselves and their employees in these situations.
Option Pool as an Incentive for Employees During an Acquisition
Companies often create an option pool to incentivize and retain talent. During an acquisition, the option pool can be a powerful tool to motivate employees to stay on board with the new company.
By offering options in the acquiring company, the new employer can show commitment to retaining key talent and rewarding them for their contributions. If the acquiring company replaces the existing option plan with their own, they may increase the size of the option pool to accommodate additional employees or provide more incentives for existing ones. This can be seen as a positive sign for employees, as it shows that the new company values their skills and wants to invest in their future.
Overall, by using the option pool strategically during an acquisition, companies can retain key talent and attract new hires who are motivated by equity incentives.
The Impact of the Option Pool on Startup Valuation During Acquisition
Startups must understand that the size of the option pool can significantly impact their valuation during acquisition. Creating an option pool dilutes the ownership percentage of existing shareholders, including founders, employees and investors.
During an acquisition, the acquiring company considers the value of outstanding options in determining the purchase price. If the option pool is large, it can result in a greater level of dilution and ultimately lower the overall valuation of the company.
For example, suppose a startup has 10 million outstanding shares and creates an option pool of 20% (2 million shares) for future employees. If the startup is acquired for $50 million, then each share would be worth $5. However, if all 2 million options are exercised before the acquisition, then there would be a total of 12 million shares outstanding. In this scenario, each share would only be worth $4.17.
Therefore, startups should carefully consider how much equity they allocate to their option pool and balance it with their need to incentivize employees and attract investors. By doing so strategically, they can minimize dilution and maximize their overall valuation during an acquisition.
Strategies for Negotiating a Favorable Treatment of the Option Pool During an Acquisition
Startups should be assertive when negotiating an acquisition, and advocate for themselves and their employees regarding how the option pool is treated. Here are some strategies that can help:
- Highlight the Value of Key Employees. One way to negotiate a more favorable treatment of the option pool is to emphasize the value of key employees and their contribution to the company’s success. By demonstrating how critical these employees are to the company’s future growth and profitability, startups can make a case for providing them with more equity incentives.
- Emphasize Alignment with Acquiring Company’s Goals. Another strategy is to show how the existing option pool aligns with the acquiring company’s goals and compensation philosophy. By demonstrating that there is already a strong cultural fit between the two companies, startups may be able to negotiate better terms for their employees.
- Be Flexible on Other Deal Terms. In some cases, startups may be able to negotiate a more favorable treatment of the option pool by being flexible on other deal terms, such as purchase price or indemnification provisions. By showing that they are willing to compromise on other issues, startups can create goodwill and leverage it into better terms for their employees.
- Seek Legal and Financial Advice. Finally, startups should seek legal and financial advice when negotiating an acquisition. Advisors can help them understand what options are available and how best to structure equity compensation plans in a way that benefits both themselves and their employees. If you are looking for legal counsel, feel free to reach out to us here.
By using these strategies effectively, startups can negotiate a more favorable treatment of the option pool during an acquisition and maximize overall value for all stakeholders involved.