The primary goal of most VC-backed companies is an exit. There are essentially two ways to achieve this goal: go public or get acquired by another company. Last week we discussed in detail what happens to employee shares and stock options when a company goes public. This post will cover the more frequent exit event – an acquisition.
While the dream for many startups is to go public, in reality the M&A (mergers and acquisitions) route is a much more common one. According to CB Insights, only 3% of exits in 2015-2016 were IPOs (initial public offerings), while the rest (about 6,700 out of 6,900 exits) were through a merger or an acquisition.
Whether it’s a direct competitor, a large company that wants to expand online, or the corporate incumbent your company was trying to defeat, the possibility that one of these companies will acquire the startup you work for is your best shot for an exit.
But what happens to your shares and options when that happens?
If you want a quick refresher on options basics, we always recommend starting here.
Stock vs. Cash M&A
When company A (we’ll call it Acquirer) acquires your company (we’ll call it Target), it can pay for the Target’s shares in two ways – with cash or with Acquirer shares. The acquisition transaction can be structured as a full cash transaction, a full stock transaction, or a mixed stock and cash transaction. The form of compensation (cash or stock) can have a significant impact on the value that Target’s founders, investors, and employees get from the transaction, and more importantly, how fast they can turn that value into cash.
While 20 years ago, most tech acquisitions were stock acquisitions, in recent years, about 90% of tech M&A transactions were cash ones. We’ll do our best to cover both options as simply as possible.
Vested Options That Have Been Exercised, aka Shares
If you already own shares, it’s pretty simple. You will get proceeds in either cash or Acquirer stock based on how many common shares you own.
While this is not the topic of this post, it’s important to note that your proceeds may not necessarily reflect your ownership percentage in Target. Meaning, if Target was sold for $100 million and your shares represent 0.1% ownership, you may not necessarily get $100,000. The reason for that is that venture capital investors typically have preferences and priorities that can bring that number down (we’ll cover that in another post). If your company is sold for a very high price compared with how much it raised from such investors, it’s possible that you’ll get your “full” $100k, but in other scenarios, you may get less. In other words, the price per-preferred-share (what investors get) and the price-per-common-share (what you get) may be dramatically different in an acquisition.
Going back our topic, let’s assume that you own 10,000 shares and the price-per-share that common shareholders get in the acquisition is $10, you will get either $100,000 in cash (pre-tax) or in Acquirer stock.
Cash is simple, but what about stock? If Acquirer is a public company, you’ll be able to sell the shares and turn them into cash immediately. You can also choose to hold them for as long as you’d like if you believe that they will continue to appreciate. If Acquirer is a private company, things get tricky and you’ll have to understand the transferability of Acquirer shares. In some cases, you’ll be able to sell them, but it could very well be that your position will be unchanged from before the acquisition. That means you’ll still be in “wait-for-exit” mode, only now you’ll have Acquirer shares instead of Target shares.
Vested Options That Have Not Been Exercised
In most cases, employees will preserve the value of their options when their company gets acquired.
If it’s a cash deal, they will typically get “cashed-out”, which means they will receive cash for the value that represents the difference between the price-per-share that common shareholders get in the acquisition and their strike price. This is essentially like exercising the option and selling the share immediately.
Going back to our example above, if the price-per-share common shareholders get is $10, and you have 5,000 vested options that have yet to be exercised at a strike price of $1 per share, your proceeds will be $45,000 [($10-$1)*5,000]. If the price-per-share is lower than the strike price, your options are basically worthless.
If it’s a stock deal, your vested options in Target will most likely convert to Acquirer stock options using a ratio and strike price that preserve their value (if greater than zero). At that point, you’ll have to decide whether to exercise them or wait. If the Acquirer is public, you can exercise your options and sell the shares immediately. If the Acquirer is private, you’ll probably have a more difficult time liquidating the shares post-exercise.
This one is a little trickier. Acquirer may choose to replace your Target unvested options with new Acquirer options that give you the same value, but it could also offer you a completely different compensation package that may not even include stock options.
In some cases, an acquisition will trigger vesting acceleration for some employees. That means that a portion or all of your unvested options will vest once an acquisition is completed. Acceleration is typically a right held for executives that have such clause in their compensation plan, but it can also be applied to others in the organization if the acquisition agreement indicates so.
While you can’t really impact whether your company is acquired for cash or stock, the one thing you can do is build great companies and increase the probability that all stakeholders, including employees, will get what they’ve earned on an exit.
[Note: we did not cover any M&A tax consequences in this post, but we will cover this important topic in a later post]
All information provided herein is for informational purposes only and should not be relied upon to make an investment decision and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. Readers are recommended to consult with a financial adviser, attorney, accountant, and any other professional that can help you understand and assess the risks associated with any investment opportunity. Private investments are highly illiquid and are not suitable for all investors.