In the current market climate, where IPOs are uncertain and valuations are a challenge, there could be an uptick in venture-backed companies getting acquired. While an acquisition can be a positive outcome, it can pay to be prepared.  Here are a few key points to keep in mind if you anticipate that your company may be acquired.

Expect FMV to change: If your company has been lowering its fair market value (aka FMV or 409A value) over the past year, but is still performing well, an acquisition offer will likely affect the FMV.  Despite its name, “fair market value” may not accurately reflect the true market value of a company’s shares, especially for younger or unprofitable companies. An acquisition offer is the market’s evaluation of the shares’ worth.

Immediate FMV Impact: An acquisition offer above the company’s FMV may lead to an immediate FMV increase, though it may not capture the full offer value. Even after an acquisition is announced, but prior to its closing, there may still be a discount, which incorporates the uncertainty of whether the acquisition will close, and the time required to close an acquisition (i.e., time value of money).  If you receive an offer before exercising vested options, you might face higher taxes than if you had exercised earlier.

Grasp Double-Trigger Features: Despite similar names, double-trigger stock options and double-trigger RSUs (restricted stock units) are different.  Double-trigger RSUs are fairly standard at private companies, whereas double-trigger stock options are usually negotiated as part of an individual’s employment agreement.  For stock options, the triggers are acquisition and involuntary termination within a specified period. This leads to accelerated vesting, safeguarding key employees facing layoffs post-acquisition.

RSUs Double-Trigger Mechanics: Double-trigger RSUs, on the other hand, hinge on an employee completing time-based vesting and the company being acquired or going public.  Vesting for double-trigger RSUs is typically similar to stock options (i.e., over a four-year period with one-year cliff).  Double-trigger RSUs were created to prevent employees from having to pay taxes on their RSUs as time-based vesting is completed.  By adding the second trigger for an acquisition or IPO, employees do not have to pay taxes on their RSUs until there is an exit event, providing employees with the liquidity needed to cover taxes.

Watch out for 280G: Section 280G of the IRS Code can lead to a 20% excise tax on “golden parachute payments” during a change of control transaction. This applies during most M&A events and may be triggered by a large payout from accelerated options vesting or just substantial option holdings. Planning ahead is crucial to help mitigate this potential tax hit.

Exercise vested ISOs promptly: The holding period for shares acquired from exercising incentive stock options (ISOs) to receive long-term capital gains tax rates, which are lower than short-term capital gains or ordinary income tax rates, is 12 months post-exercise and 24 months after the grant date. Exercising ISOs at least 12 months before a potential acquisition can help secure tax benefits. Waiting too long or selling too soon may lead to higher tax liabilities.

Watchout for blackout periods: Not being able to exercise your options before an acquisition offer is made or before the acquisition closes can be frustrating.  Acquisition negotiations are highly confidential, and with the exception of a small group of executives, employees may have no idea negotiations are happening until the blackout period becomes effective, at which point it is potentially too late.  While companies may let employees provide an exercise notice during a blackout period, they will generally have to use the updated FMV once it is announced.

Consider exercising expiring options: If your options are expiring within one year of an acquisition offer, you may consider exercising them rather than stressing over losing them.  With the federal government taking a harder stance on competition and acquisitions, delays in closings have become more common.  Recent examples include Intuit’s acquisition of Credit Karma (over 11 months) and Microsoft’s acquisition of Activision (over 20 months).

Prepare for job instability: In many situations, acquisitions lead to overlapping positions, which means someone could lose their job.  While many companies will make accommodations if someone is laid off, these accommodations may convert ISOs to NSOs and generally only offer more time to exercise, but not an easier financial path to exercising stock options.

Consider share liquidity: Acquisitions can be rife with uncertainty (i.e., prolonged processes, potential bidding wars and competition between redundant employees).  Having some additional liquidity can help cushion these situations. If you have already exercised your options or hold shares, you might consider a private share liquidity transaction to help provide an extra financial safety net.

At Liquid Stock, we understand that navigating stock options can be a complex endeavor, especially when confronted with the uncertainty of an impending acquisition. We encourage you to connect with your advisors and our dedicated team if there’s a potential acquisition on the horizon for your company. Our solutions can help you proactively equip yourself for any potential scenarios.

This blog post is intended for general informational and education purposes only.  Liquid Capital Management, LLC (together with its affiliates, “Liquid Stock”) makes no representations as to the accuracy of information in this post, and no representations or guarantees as to specific outcomes from relying on this post. No content in this post is intended or should be construed as tax, investment, legal or accounting advice by Liquid Stock, or as an offer to sell or solicitation of interest to purchase any securities offered by Liquid Stock. Liquid Stock does not provide tax or other financial, legal or regulatory advice to its transaction counterparties. Always consult with your investment, tax, and legal advisors before making important financial decisions. The terms of any Liquid Stock transaction may vary. Outcomes (including financial and tax outcomes) of any transaction will depend on factors including the timing and value of any liquidity event.  While reasonable steps have been taken to ensure that the information herein is accurate and up to date, no liability can be accepted for any errors or omissions. All views and information contained herein are as of the date hereof and subject to change. Views and opinions presented are those of the author. Information contained in third-party links has not been independently verified by Liquid Stock and inclusion of such links should not be interpreted as an endorsement or confirmation of the content therein. Prospective investors considering an investment in a Liquid Stock fund should not consider this content as fund marketing material.