By Judith Lu
After months of lawsuits and uncertainty, the world’s richest man Elon Musk finally purchased Twitter for $44 billion, soaring the social media platform to a new age. With the purchase of Twitter comes the question of equity compensation.
When most employees find out that another company is buying out their employer, it is usually regarded as good news. This is because the company is often purchased at a premium to the company’s fair market value. However, the worry-free mentality may not apply to employees who own stock options.
The Twitter case has some employees compensated with stock options wondering about the potential pitfalls of getting paid in company stock. Many Twitter employees have shared their concerns over losing their equity compensation if Musk fires them before their shares vest. This is a serious concern for any employee with stock options and the possibility of a company buyout.
In the spirit of sharing knowledge, the entry below outlines how lucrative a company buyout can be to employees who own stock options.
Equity Compensation Post-Buyout
The type of equity and whether it is vested or unvested are the main factors that determine what happens to stock options after the sale of a company. Factors such as the terms of the deal, the value of acquiring the company’s stock relative to the buying company, and how the purchase impacts the shares’ value can also impact stock options.
Companies have different equity plans for incentivizing staff. Employees can also receive different types of equity-based compensation at once. Restricted stock units (RSUs), restricted stock awards, and stock appreciation rights (SARs) are standard forms of equity compensation.
Unfortunately, employees will not know what happens to stock options until the sale is final. Even after approval of the sale, learning what will happen to your case may take some time. However, there are a few general possible outcomes.
Vested Stock Options
Vested stock options mean you have rights to certain guarantees as stated in the grant agreement. If the takeover price is higher than the strike price of your stock option, then you can profit from the difference.
Stock options and RSUs can be vested or unvested. Vested means they belong to you and they almost always settle in shares or cash. So, you have the right to buy shares or receive some money in place of shares. During an acquisition, the current employer can handle vested stock options in the 3 following ways:
Liquidate your equity position
The company will cash out your options and liquidate your equity. The amount you will receive will depend on the current strike price, the new price per share, and other negotiated payment terms.
Assume or substitute your stock options
The acquiring company can undertake the value of your vested options or substitute them with their own stock. In both cases, you will keep holding your options to exercise.
Cancel underwater vested grants
If your options are underwater (the current market value and/or the takeover price is lower than the strike price), the option becomes worthless, even if vested. The purchasing company may or may not make an offerto compensate you. If they do, you may receive a nominal amount for canceling the grant.
To Exercise Or Not To Exercise?
Because of the above possible outcomes, many people wonder if they should exercise their stock options before the buyout. There are pros and cons to exercising vested stock options before the deal closes.
When unexercised stock options are cashed out at closing, it is not considered a disqualifying disposition for tax purposes, but rather a cancellation of stock options. In this case, the stock options will be subject to payroll tax. Many people exercise their options prior to the deal closing in order to avoid the tax.
Others choose to wait to for the terms of the deal to be known. If the deal is delayed, however, or does not close, the stock options could trigger AMT (alternative minimum tax) if you hold them through the end of the year.
If you wait and the deal does not end up closing, you could find yourself saddled with a large tax bill and possibly not enough liquidity to pay it. For this reason, it’s important to weigh the pros and cons before holding out until the deal closes.
The key to getting the best outcome is advanced planning. There will likely be a period of time where employees will not know the final outcome of the acquisition until it is announced. As such, we encourage you to consult with your accountant and financial advisor to determine the best course of action for your personal financial situation.
Judith Lu is the CEO and Founder of Blue Zone Wealth Advisors, a wealth and investment management firm serving families and individuals in Southern California and across the United States. To learn more, please visit bluezoneadvisory.com.