Learn the differences and compare the trade-offs between cash and stock so you can make a more informed decision.
The announcement has just gone out that your company will be acquired. Now what?
If you have equity awards, an acquisition might mean a cash payout, a conversion into new shares of the acquiring company or some combination of the two. While the exact details vary depending on your company’s particular plan, how long you've been at the company and the terms of the deal, it's helpful to understand how mergers and acquisitions can impact equity awards.
When one company acquires another in an equity deal, it acquires all the outstanding shares of a company. During a stock merger, shares from one company may be exchanged for shares of the other, or new stock may be issued if the merged companies result in a new entity. The deal announcement typically includes key details, such as how much your company is being acquired for and the expected closing date, subject to various factors.
If you are a shareholder of the company being acquired, you may have the option to receive cash or shares. Meanwhile, your company may suspend its employee stock purchase plan (if it offers one) and not allow any new stock purchase or issue new equity awards to employees starting on a specific date.
Every deal is different. Sometimes an acquirer will convert shares to the acquiring company stock and make small or no changes to the award structure. Other times, the underlying structure to equity awards could change drastically, with changes to vesting schedules, performance criteria or even the type of equity compensation you hold. While this article discusses some common scenarios, you must review the information provided by your company regarding your company’s transaction and your equity awards.
Another factor to keep in mind is external forces. Months can pass between the acquisition announcement and the deal close. During that time, economic shifts, market sentiment, and regulatory or political concerns can impact the deal and the value of your equity awards. If the deal is well received and leads to higher stock prices, it may enhance the value of your awards. Market or economic forces and regulatory scrutiny can also slow the deal or create a drag on stock prices. As an employee, staying informed and having a broad perspective on what to expect can help you explore your options and be well positioned to manage your awards.
The type of equity awards you hold can make a big difference in your compensation and potential tax bill. As a first step, you may want to review your stock plan account to familiarize yourself with the status of your equity awards, including the value of your unvested or vested stock options or restricted stock units, the market price, and vesting period.
Second, you can prepare yourself by learning more about the types of awards you hold and the potential implications. Here are some general considerations to take into account:
Stock options are a form of equity compensation that give you the right to buy a certain number of shares at a set price (typically below market value) called the strike or exercise price. Stock options typically come with a vesting period, which may be anywhere from one to three years, or more. The vesting period can incentivize you to stay at your company and earn the right to buy shares at a predetermined price. Once stock options are vested, you can exercise (or buy) them.
In an M&A event, unvested stock options in the acquired company may be converted into unvested stock options of the acquiring company. The exercise price, vesting schedule and other terms will vary depending on the terms of the acquisition. The terms could be similar, or you could be offered a cash or stock buyout based on the value of the unvested stock options. Stock options could also be cancelled, taking away the opportunity to exercise your options.
If you have vested stock options, the acquiring company may convert those into its own vested stock options, or the company could provide a cash payout instead. A payout is usually based on the value of the options—that's the difference between the exercise price and the market value of the acquiring company's stock.
Non-qualified stock options let you buy a set number of shares at a preset price within a certain timeframe. During a merger or acquisition, you typically will have a period of time to decide if you want to exercise your vested options or forfeit them. This type of stock does not qualify for special favorable tax treatment like ISOs. How long you hold the shares determines whether you pay long-term or short-term capital gains tax when you sell the underlying shares.
These options give you the right to buy company stock at a predetermined price and come with potential preferential tax treatment. If you hold ISOs for at least two years after receiving the options and one year after buying the stock, you would be taxed at the more favorable long-term capital gains tax rate. Companies offer incentive stock options to attract and motivate employees. These options often come with vesting schedules and a 10-year exercise period. Like non-qualified stock options, you could have a limited time to decide if you want to buy or forfeit incentive stock options during an acquisition.
Also called RSUs, restricted stock units are another form of equity compensation. But unlike stock options, which give employees the right to buy at a certain price, stock settled RSUs are the promise to deliver a set number of shares after a vesting period. The vesting period can be time-based, performance-based or a combination.
Once RSUs have gone through the vesting period, they become vested RSUs. When RSUs vest, you receive your company shares, and you’ll owe federal ordinary income tax on the fair market value (that’s the value the shares would trade at on the open market) of your shares at the time of settlement. Later, if you sell your shares, you may owe short-term or long-term federal capital gains taxes depending on how long you held the shares. One thing to note: Your company may have a trading window restriction (also known as a blackout period) or certain internal policies limiting when you can sell to mitigate insider trading risks.
When your company is acquired, the acquiring company might allow unvested RSUs to continue vesting according to the original schedule. In some cases, an acquisition could speed up the vesting period, which may result in your RSUs becoming fully vested after the acquisition.
If you have vested RSUs, those can be converted into shares of the acquiring company, or you may receive a cash payout that's based on the market value of the acquiring company's stock at the time. The terms will vary depending on the transaction agreement.
Similar to stock options and RSUs, PSUs are usually granted as part of a long-term incentive plan for employees. PSUs have a unique vesting schedule that could be a mix of time-based vesting as well as personal or company performance-based criteria. Refer to your plan documents for details about your specific award. Treatment of PSUs can vary in an acquisition. There could be no changes, or they might be wrapped into a different equity compensation plan or even cancelled.
If you have a choice between cash or stock, it can be helpful to compare by modeling what taking all cash, all stock or some combination means to your income and taxes. If you have a spouse who also has equity awards from their employer, you may want to coordinate if and when you sell your shares to help minimize taxes. Sometimes, if you hold on to ISOs longer, instead of exercising and selling immediately after the vesting period, you may be taxed at the lower long-term capital gains tax rate. It can be helpful to model out income for the coming two years to figure out the most tax-efficient way to exercise remaining options or RSUs. A Financial Advisor can help you to model different election options, timelines and tax implications, and consider the outcomes in light of your full financial picture.
An acquisition can bring a mix of stress and excitement, especially when it comes to your equity awards. It could mean a windfall that changes your overall financial outlook but may also have the potential to create a large tax event. To make the most of the opportunity, you need to consider your current situation, the choices available to you, and what the possible tax implications could be. Having the support of financial professionals who are familiar with how to manage equity awards during M&A deals can help you make the most informed decision when it comes time. Not sure where to start? Connect with a Morgan Stanley Financial Advisor, and make sure to walk through these five important considerations to understand the potential implications of your election options.
In addition to working with an experienced Financial Advisor, having a dedicated tax professional or CPA who understands the nuances related to an M&A event can help give you a full understanding of the potential tax implications. Here are some important questions to review with your tax advisor or CPA:
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