Tips for Managing Your Equity Compensation Grants During a Merger or Acquisition

Tips for Managing Your Equity Compensation Grants During a Merger or Acquisition

February 12, 2020

Over the past many years, M&A activity have increased substantially in the life sciences field to create partnerships that allows for strategic growth and to deliver turnkey results for patients and to cure diseases.

These activities bring with themselves more complicated solutions as it comes to equity grants – especially as there are multiple ways stock options or stock grants can be transferred at time of transition and it will mainly depend on the two negotiating parties. We will address changes to stock options and Restricted Stock (RSUs) in time of acquisition in this article - as these are the most frequent grants.

Stock Options:

I have to start again by pointing out, know your documents and especially understand the terms at time of hire already. Even though the final M&A deal will ultimately decide what your equity grant is worth with the acquisition, your grant agreement as well as the summary plan description for your company’s stock option plan will detail what happens to your options at time of merger and acquisition or in time of “change in control”.

  • Vested Options: As for your vested options, your company has to honor them unless it was stated differently in the grant agreement. By law, the buyer in nearly all cases will take over the contractual obligations of the company it acquires. The acquisition can be structured in multiple ways. Your options can be terminated and you receive cash in exchange. You can receive new options of the acquiring company and the amount will depend on the stock exchange ratio that was agreed on between the parties. It can also happen that they give you a choice between these two and you have to potentially exercise all your vested options before the M&A is finalized. Please remember, there are lot of decisions to make that can have various tax consequences therefor you need to know your grants and your agreements.

  • Unvested options: This can be a grey area and definitely something you should pay attention to. There is a possibility that the acquiring company will convert your unvested options with current firm to its own unvested options and you will keep the vesting schedule. It is also possible that the acquiring company will not honor any of your unvested options, therefore you will lose them. If you stay with the new company as an employee, they might provide you with a new grant under their own grant agreement with new vesting.

The most common event at time of M&A is acceleration of vesting of your unvested grants including options. Your agreement should spell out the triggering events for acceleration, change of control at your company is usually one of them. The agreement might call for full or partial acceleration of vesting of grants. In case your company grants you ISOs (incentive stock options), you might find, that some of them become NQSOs (non-qualified stock options) at an acceleration event. This is due to the rule that you can’t exercise more than $100K worth of ISOs in one calendar year. Depending on the stock price and size of your grant, it is fairly common to lose the tax benefit of ISOs at such an event.

Restricted Stock Units (RSUs):

Restricted Stock Units have become very popular in the last few years, significantly increasing grants – especially at mid and larger size companies. Upside leverage is not as meaningful than with options but RSUs provide a sure way of receiving equity in the company and they are way less complex than options.

Vested RSUs: As RSUs vest, they immediately transfer to the employee in form of company stock and you will pay ordinary income on the value of the vested portion which is the current market value of the vested shares. The acquiring company can decide to convert these shares into its own stock or purchase the shares from you.

Unvested RSUs: There are various factors that will affect unvested RSUs and those include but not limited to the continuity of your employment with the new company, the current grant agreement in place for employees. No matter what the outcomes are similar to those as with options. Accelerated vesting is very common in case of RSUs as well. Basically, you will be granted common stock by your new company in exchange for your old RSUs that you will lose. If the acquiring company has an equity compensation plan in place, they may honor your old agreement and offer you RSUs with a vesting schedule that is comparable to your old grant and also in alignment with the new company’s equity grant practices.

Please remember that the new company might decide to cancel your unvested RSUs or simply purchase them fully or partially. They can pay you with cash and/or stock.

As you can see there are many variables that you have to pay attention to and taxation of these various outcomes is one of them. Whenever you receive cash for your RSU grant, you will be subject to ordinary income and when you get paid with stock, you will have to follow capital gain taxation rules or in case of tax-free stock exchange, you will not pay capital gain taxes till you sell the shares. If your company decides to cancel the old grants and offer you a new one, most probably there will be no tax consequences. Please consult your tax accountant in advance so you know what to expect in advance and can plan.