Stock options can be a major part of compensation packages. In the event of a company merger, it is important to know what will happen to your stock options.
Here we discuss eight ways to maximize the value of your stock options in a merger. Working with an advisor who has direct experience can help you achieve your desired financial outcome.
1. Review vesting Acceleration Clauses
Stock option plans often include acceleration clauses, which accelerate the vesting process of options that are not yet vested in the event of a merger.
There are two main types:
- Single trigger acceleration: Unvested Options vest immediately after the closing of mergers and acquisitions (M&A).
- Double-trigger Acceleration: Unvested Options vest only when the merger occurs and you are terminated within a specified period without cause.
Certain plans do not include vesting acceleration terms, and the relevant terms can be different for each employee. Some key employees will negotiate vesting acceleration clauses in their employment contracts.
An excellent financial advisor is more than just a superficial review of your stock option agreement. They will go deeper to fully understand your options, how an event may impact your financial situation and assist you in planning.
2. Understanding if your options will be converted or cashed out
During a merger and acquisition, the acquiring firm may convert stock options into its own stock or cancel them completely or may cash out your stock options.
You can cash out your options to receive a lump-sum of cash. This is the easiest way, but you must ensure that the cash-out represents the full value of your options.
If your options are converted into the stock of the new company, you will need to assess its financial potential and health. In general, the equity value of the employee in the acquired company will translate into an economic interest for the acquirer. A ratio is usually applied to all figures relevant (exercise prices, quantities, and share prices) between Company A and Company B.
Acquiring companies will use a combination of cash and equity to make the acquisition. This is easier from the cash flow point of view (as they can purchase using stock and not cash) and aligns the employee incentives.
3. Decide if and when to exercise your options
After the conversion, the employee will need to decide whether or not they want to buy shares in the company. It is important to consider the upside potential of the new company, its tax implications, as well as how an exercise decision could impact other priorities in a financial plan. This analysis should include the path of the acquiring company to future liquidity and exit.
Financial advisors can help you weigh the pros and cons in both scenarios. You’ve already invested sweat equity, and perhaps some cash in this company. What are the benefits of investing more? To make an informed decision, it is important to analyze the terms of the merger and possible scenarios. There is no blanket recommendation in these scenarios. Instead, you need to make decisions from a holistic point of view and ensure they align with your goals.
4. Tax implications: How to manage them?
M&A transactions can have a significant tax impact on some employees, particularly if there is a cash component involved. This can lead to an income year that is higher than usual, which opens up opportunities for planning. One common approach is to take advantage of higher-than-usual regular income (and tax), which may allow you to exercise Incentive Stock Options without paying the dreaded Alternative Minimum Tax (AMT). Taking that step can help position you for a better tax outcome during a future liquidity event without adding too much concentration risk.
If you are working with a financial advisor, then you can expect that they will help you optimize your tax decisions in those years of high income. You may wish to explore ways to reduce taxable income, or defer income from other sources.
5. Monitor the acquiring company’s stock
Mergers can cause stock prices to fluctuate if the company acquiring is a publicly traded firm. Stock prices can rise if markets react positively to the merger or fall if integration is difficult. Both of these emotional reactions can affect the stock price. Consider employee trading windows, and whether it makes sense to use a 10b5-1 stock plan.
A good financial advisor will monitor the stock closely and give you ongoing advice about whether or not to sell it, based on current market conditions and your portfolio. They’ll also give you advice on how to integrate this stock into your overall financial plan, and whether or not you are overexposed in any particular area.
6. Review retention packages as well as new employment terms
As part of a merger, executives are often given new retention packages to help them stay with the company through the transition. These packages may include stock options or bonuses in addition to the standard package. The terms can vary greatly. You should carefully review any new contract, especially any changes to the vesting schedules and clawback provisions.
It is important to understand these terms, and a consultant can give you guidance about what the future holds.
7. Beware of clawback provisions
Most M&A agreements include clawback clauses, which give the acquiring company the right to reclaim some or all options granted if certain conditions, like leaving the company in a specified time frame after the merger, are met. If you are planning to leave your company after the merger, it is important to understand if there is a clawback provision and how that could impact your payout.
8. Plan for liquidity and easy access to funds
It is important to have liquid assets available during and after a merger. You could find yourself in a situation where you are unable to access your funds if your stock options have been converted to illiquid stock or if they are subject to a “lock-up” period. It is not only a financial risk to have your assets locked away, but it can also cause anxiety and stress because you feel like your future depends on a single share price. Your advisor’s job is to guide you during these times and to minimize your reaction to short-term events. Financial success is dependent on having a long-term perspective and not “counting your chickens before they’ve hatched”
A merger or purchase can have a profound impact on your financial life. M&As can have positive outcomes but it is important to plan ahead. Parr & Ibarra not only help you with the basics, but also offer you personalized and strategic advice to help you make informed decisions about your financial future.
