A takeover of one company by another can be a nervous time for employees. It is natural for people in this situation to feel a little insecure and wonder if their job will even exist once the takeover has been completed. This uncertainty will also apply to pre-existing employee share plans in the company being bought over.
Consolidation is a fact of life in business nowadays, with data from 2020 indicating that the value of global mergers and acquisitions for that year amounted to $2.8 trillion. This was down from the previous year’s total of $3.4 trillion, but the broad trend in recent decades has been for the value of these deals to rise over time.
What happens to share options in a takeover?
In a takeover scenario, the purchasing company could take one of any number of approaches as it relates to employee share plans. Several factors will be in play, not least of which being the kind of plan an employee has signed up to and the general attitude of the purchasing company towards equity compensation. Depending upon those factors and others, the potential outcome for the participant can range from highly desirable to worst case scenario.
So, against that backdrop, what happens to your shares after a takeover will in part be determined by whether your options are vested (already transferred to you or you have secured the right to buy shares at a certain price) or unvested (promised to you but not fully earned as of yet, for whatever reasons).
What happens with vested options during a takeover?
With vested options, the acquiring company will generally opt for one of three courses of action:
1. Shares/options may be cashed out: Under this approach, all shares are converted to cash. There are several scenarios under which new owners might opt for this course of action. For example, if they don’t offer equity compensation to their existing employees, it is unlikely that they would want to do so for those being brought on board through a takeover.
In that situation, converting shares and options into cash means employees will longer own any equity in the company. Also, if the purchasing company does not plan on retaining all staff in the business being taken over, at that point it would suit their interests to cash out those being let go.
2. Shares/options may be assumed: The purchasing company may choose to assume the value of vested options they inherit from the company they have taken over. With this, the existing plan is basically allowed to continue as if nothing had changed.
For the participant, this means they can choose to hold on to their options or look to exercise them. It might suit the new owners to go with this approach if they consciously want to avoid diluting their own shares.
3. Shares/options may be substituted: This is similar to the above option, but instead of retaining the existing plan, the acquiring company would cancel it and replace it with new awards for those employees under the terms of their own share plan.
What happens with unvested options during a takeover?
With unvested options, all the above options could be considered by the new owners, but they might also choose a different course of action. Among the other possibilities are:
1. Options may be cancelled: This is the worst-case scenario for plan participants. An acquiring company is under no obligation to honour unvested options, so it could choose to cancel any outstanding share incentives that have not yet been earned.
Informed commentators stress that this isn’t the most likely path for new owners to pursue. While it can happen and has happened, cancelling options with no payout would only serve to complicate the relationship between the new owners and employees from the outset, and so a sweeping move of that nature is generally avoided.
2. Accelerated vesting: This approach speeds up the vesting process and could be beyond the control of the acquiring company, in that it may be written into the original options agreement that partial or full acceleration will be triggered in the event of a takeover.
While this is favourable for employees, it is not necessarily ideal for the acquiring company. When options become fully vested and are exercised, at that point, theoretically, those employees have less incentive to stick around and will be open to offers from elsewhere. At the very least, this can complicate whatever retention strategy might have been envisaged.
While there may be justifiable nerves whenever a company is acquired by new owners, generally it is not in their best interests to collapse or negatively effect the current employee share plan.