Startup stock options are complicated. Do you know what happens to your options if your company gets acquired? You might not get what you think you should. I’ll go over one big issue that you can check on right now.
We’re going to check whether you get full vesting acceleration if your company gets acquired *AND* the acquirer does not assume the company’s option plan. WTF does that mean?
(This is related to but different than single-trigger and double-trigger acceleration, which you may have read about. I’m not covering those here. See Fred Wilson and Brad Feld for primers on vesting.)
Your Startup Succeeds
Let’s say you’re an early employee at a startup and you get a grant for options representing 1% of the company with 4 year vesting. Two years after you accept this offer, the company gets acquired for tens of millions of dollars without taking any new funding. This is great! You can exercise your options for a tiny amount, and they are worth a lot.
Since you’ve been there for 2 years, half of your options are vested. No one can take those away from you. But what happens to the other half?
The acquirer—your new boss—comes to you and says that the remaining half of your options are gone. If you want to keep your job, you have to sign a new equity agreement which won’t make you nearly as much money and comes with a new 4 year vesting schedule that starts today. Can they do that?
Your company’s option plan
The answer depends on your company’s option plan—most often called an equity incentive plan. Your company has one of these to govern all options granted to employees. If you don’t have a copy, get one from whoever handles HR at your company.
Here’s what you’re looking for. From Brad Feld and Jason Mendelson’s Venture Deals in the section “Assumption of Options”: “Most contemporary option plans have provisions whereby all granted options fully vest immediately prior to an acquisition should the plan and/or options underneath the plan not be assumed by the buyer.” An example of what this provision looks like is at the bottom of this post.
This standard provision is good for you. It means that the acquirer has a few options: (1) keep your same option agreement in place—same exercise price, same number of shares, same vesting, (2) replace your option agreement using the acquirer’s stock in a way that is no worse to you in terms of total payout and vesting schedule, or (3) let you exercise all your vested and unvested options now.
In short, you’ll be in at least as good a position after the acquisition as you were before it. (But note this doesn’t mean everything will be perfect. If the acquirer decides that you are no longer needed, they could keep your option agreement intact and terminate your employment. You wouldn’t get any further vesting unless you have single-trigger or double-trigger acceleration, and you’d be out of a job. It would be the same as if you’d been fired by your company before the acquisition.)
Times are changing
The problem is that some acquirers and investors are trying to change this. They want option plans to say that there is no vesting acceleration regardless of whether the acquirer assumes the option plan. This means that the acquirer can simply cancel any unvested options and offer you whatever equity compensation they want.
A few Bay Area serial acquirers are pushing for this. It allows them to structure retention packages for their new employees in any way they see fit. Some investors also like it because cancelled options mean they get more of the payout. (To be fair, all shareholders including founders get more of the payout.)
PERSONAL OPINION ALERT: This new trend is BS. Employee and company agreed to a deal. That deal is being pulled away by the acquirer in a way that the employee probably never knew possible. Most employees have never even seen their option plan. As a founder, I’d feel incredibly sleazy about having this type of landmine hidden away in the option plan. By keeping to the standard option plan language, acquirers have a much harder time forcing bad deals down their new employees’ throats.
The situation that is most likely to lead to problems is if the acquirer wants to keep an employee but at reduced equity compensation. Full acceleration means the acquirer can’t force a much less lucrative deal on the employee by saying they’ll be out of a job if they don’t accept the new deal. It instead forces the acquirer to honor the existing option agreement if they believe the employee is valuable. It changes the starting point of the negotiation between employee and their new boss.
Your option plan should give you full acceleration if an acquirer does not assume the company’s option plan (or replace it with an equivalent plan). If you don’t have that, it is worth thinking through how it could be used against you. This is especially true if you are likely to have a lot of unvested options when your company gets acquired.
Sample provision regarding assumption of option plan. This is a long, complicated provision. The bolded language in the second paragraph is the key.
Merger or Change in Control. In the event of a merger or Change in Control, each outstanding Award will be treated as the Administrator determines (subject to the provisions of the following paragraph) without a Participant’s consent, including, without limitation, that (i) Awards will be assumed, or substantially equivalent Awards will be substituted, by the acquiring or succeeding corporation (or an affiliate thereof) with appropriate adjustments as to the number and kind of shares and prices; (ii) upon written notice to a Participant, that the Participant’s Awards will terminate upon or immediately prior to the consummation of such merger or Change in Control; (iii) outstanding Awards will vest and become exercisable, realizable, or payable, or restrictions applicable to an Award will lapse, in whole or in part prior to or upon consummation of such merger or Change in Control, and, to the extent the Administrator determines, terminate upon or immediately prior to the effectiveness of such merger or Change in Control; (iv) (A) the termination of an Award in exchange for an amount of cash and/or property, if any, equal to the amount that would have been attained upon the exercise of such Award or realization of the Participant’s rights as of the date of the occurrence of the transaction (and, for the avoidance of doubt, if as of the date of the occurrence of the transaction the Administrator determines in good faith that no amount would have been attained upon the exercise of such Award or realization of the Participant’s rights, then such Award may be terminated by the Company without payment), or (B) the replacement of such Award with other rights or property selected by the Administrator in its sole discretion; or (v) any combination of the foregoing. In taking any of the actions permitted under this subsection 13©, the Administrator will not be obligated to treat all Awards, all Awards held by a Participant, or all Awards of the same type, similarly.
In the event that the successor corporation does not assume or substitute for the Award (or portion thereof), the Participant will fully vest in and have the right to exercise all of his or her outstanding Options and Stock Appreciation Rights, including Shares as to which such Awards would not otherwise be vested or exercisable, all restrictions on Restricted Stock and Restricted Stock Units will lapse, and, with respect to Awards with performance-based vesting, all performance goals or other vesting criteria will be deemed achieved at one hundred percent (100%) of target levels and all other terms and conditions met. In addition, if an Option or Stock Appreciation Right is not assumed or substituted in the event of a merger or Change in Control, the Administrator will notify the Participant in writing or electronically that the Option or Stock Appreciation Right will be exercisable for a period of time determined by the Administrator in its sole discretion, and the Option or Stock Appreciation Right will terminate upon the expiration of such period.
For the purposes of this subsection 13©, an Award will be considered assumed if, following the merger or Change in Control, the Award confers the right to purchase or receive, for each Share subject to the Award immediately prior to the merger or Change in Control, the consideration (whether stock, cash, or other securities or property) received in the merger or Change in Control by holders of Common Stock for each Share held on the effective date of the transaction (and if holders were offered a choice of consideration, the type of consideration chosen by the holders of a majority of the outstanding Shares); provided, however, that if such consideration received in the merger or Change in Control is not solely common stock of the successor corporation or its Parent, the Administrator may, with the consent of the successor corporation, provide for the consideration to be received upon the exercise of an Option or Stock Appreciation Right or upon the payout of a Restricted Stock Unit, for each Share subject to such Award, to be solely common stock of the successor corporation or its Parent equal in fair market value to the per share consideration received by holders of Common Stock in the merger or Change in Control.
Notwithstanding anything in this Section 13© to the contrary, an Award that vests, is earned or paid-out upon the satisfaction of one or more performance goals will not be considered assumed if the Company or its successor modifies any of such performance goals without the Participant’s consent; provided, however, a modification to such performance goals only to reflect the successor corporation’s post-Change in Control corporate structure will not be deemed to invalidate an otherwise valid Award assumption.