What Happens on an Acquisition or IPO
If you’re an employee at a private company, you may have been given stock options. These options give you the right to buy a certain number of your company’s shares at a fixed price, called the “strike price,” at a particular point in the future. These options can form a significant part of your compensation package.
Some startups may eventually pursue a liquidity event, such as being bought by another company (an acquisition) or offering shares to the public for the first time through an initial public offering (an “IPO”). These moments are known as “liquidity events,” because they can create an opportunity for shareholders to sell their shares.
Not all companies make it to these milestones, however. For those that do, the type of options you initially receive — along with the value of your shares and any taxes you may owe — can affect whether you ultimately make a profit, and if you come out ahead at all.
What Happens to Stock Options and Shares During an Acquisition
When your company is bought by another, there’s no one-size-fits-all answer for what happens to your stock options or shares. The way your stock will be affected depends on the negotiated deal, the terms of your equity plan or option agreement, and how your company’s previous funding rounds were structured.
Three common ways that your stock options or shares may change include:
Cash Payout
Your vested options (options you’ve earned the right to exercise) may be “cashed out.” This usually means you automatically “exercise” your options (buy the shares at your strike price), and then the acquiring company immediately buys those shares from you for cash, based on the acquisition price. In this instance, you’ll typically receive a cash payment of the difference between the sale price and your strike price, minus any applicable taxes.
Stock-for-Stock Exchange
Instead of cash, your shares might be exchanged for stock in the acquiring company, based on a ratio determined under the terms of the transaction. You could also get a combination of money and stock.
Option Rollover or Substitution
Your existing stock options could be replaced with new options in the acquiring company, often with adjusted terms to reflect the deal. What happens to them depends on the terms of the deal and on your equity plan. They may be canceled, vested early, or turned into awards in the acquiring company. In some cases, your unvested options keep vesting on a new or adjusted schedule.
Remember: if your company is acquired, there’ll be lots of fine print involved, which can affect what you owe in tax. It’s a good idea to seek advice from a tax advisor who can help with your personal situation.
How Common Stock or Preferred Stock Affects Your Payout in an Acquisition
Not all acquisitions are good for employee stock. Understanding what kind of shares you own is important to understand how much money you might get during your company’s exit.
- Common stock: As an employee or founder, your stock options typically give you the right to buy common stock, which is the basic type of ownership in a company.
- Preferred stock: This is usually the type of stock that investors (like venture capitalists or large investment firms) receive when they put money into the company. Preferred stock comes with special rights called “liquidation preferences.”
The liquidation preference means that in an acquisition, preferred shareholders get paid back their original investment (or sometimes a multiple of it) before common shareholders start receiving any of their money.
If the company is acquired at a valuation that is higher than the total capital that preferred investors put in, then after the preferred shareholders are paid back their investment, there’s usually enough left over for the common shareholders to get a payout.
If the company is acquired for less than the amount of preferred capital, the preferred shareholders might take most — or even all — of the money, due to their liquidation preference. This can mean common shareholders, including those who exercised options, receive little or nothing, even though the company technically had an exit.
Think of your common shares as an asset, like your house. In this scenario, the preferred investors are your mortgage. If you sell your house for less than or equal to the amount of the mortgage, then the bank takes everything and you get nothing. If you sell for more than the amount due on the mortgage, then you get something. If you sell for a lot more than the mortgage, you could do really well.
What Happens to Stock Options and Shares During an IPO
When your company files for an IPO, it means it’s preparing to offer its shares to the general public for the first time on a stock exchange. Few businesses make it to this milestone, and it’s a big moment. When the IPO is complete, your stock options and shares will work differently.
Vested Options Must Become Shares
A company’s stock option plan often has a requirement that any vested stock options are immediately exercised right before the IPO, provided that the IPO price is higher than your strike price. This automatic process means that a company’s equity administrator or a designated broker handles the mechanics of purchasing the shares for you. When you’ve completed this process, you’ll receive shares in this newly publicly traded company (and you’ll also likely need to pay tax).
Vesting Continues
If you have unvested options when the company IPOs, your vesting schedule usually continues as normal. You’ll earn the right to buy more shares as you continue to work for the now-public company.
Preferred Shares Convert to Common Shares
Preferred shares — the kind of stock that investors receive — typically convert to common stock automatically at IPO. That means that investors lose their liquidation preferences, so everyone owns the same kind of shares and participates equitably in the upside.
Lock-Up Periods
After the IPO, you often can’t sell your shares immediately. Most IPOs include a lock-up period (usually 90 to 180 days) for employees and early investors. This prevents a flood of shares from hitting the market right away, which could drive down the price.
Trading on the Exchange
Once the lock-up period expires, your shares become freely tradable on the public stock exchange. You can then sell them through a standard brokerage account.
Getting a company ready for an IPO takes time. It involves working with big banks; filling out official government paperwork; and going on a “roadshow,” where the business’s leaders try to convince institutional investors to buy their shares. Next, the company and its bankers decide how many shares to sell and who will buy them, as well as setting the starting price based on what these new investors are willing to pay. After that, the company’s shares start being bought and sold by the public on a stock market.
How to Unlock the Value of Your Shares Before an Exit
An IPO or an acquisition is a big moment in the trajectory of a company and it can create a significant payday for shareholders or those with vested options. But because how much you receive is based on factors beyond your control — such as your company’s valuation, what percentage of the stock is preferred or common, and what timeline the exit is following — you may not receive the payout that you’re hoping for.
Another way to potentially unlock the value of your equity in a company is to sell your shares on an institutional-grade investment platform like Mirai Capital. After you’ve signed up for an account, Mirai Capital provides insight into the market-driven price of your company’s shares. You can then place a sell indication, setting your target price, the number of shares you want to sell, and how long the indication stays live. Mirai Capital then shows you interested buyers, including the price and size of their interest.
To engage, you can proceed at the buyer’s stated size and price, or adjust with your counter terms. The buyer can then add your offer to their order, or counter back.
Once the buyer confirms by placing their order, you officially match and start transacting. Mirai Capital will guide you through every step, and will organize the paperwork, contact the issuer, and settle the trade.