Liquidity Events: IPOs and Acquisitions
Option holders generally realize liquidity only during an exit event, such as an acquisition or an Initial Public Offering (IPO).
Initial Public Offering (IPO). When a company lists its shares on a public exchange, option holders can exercise their options and sell the resulting shares. For instance, if you hold 2,000 options with a strike price of $150 and the stock trades at $300 post-IPO, you can exercise and sell. The difference between the market price and the strike price is the spread ($150 per share). Exercising costs $300,000 (), and selling yields $600,000, resulting in a $300,000 gross profit before taxes and transaction fees.
Do not plan on selling into the pop. Underwriters impose a lockup — typically 90 to 180 days post-IPO — during which insiders and employees cannot sell. This is a contractual restriction in the underwriting agreement, not a securities-law rule, so the length is whatever your company negotiated: read the actual number in your own documents instead of assuming 180 days. The tax consequence is that your vesting-date income and your ability to convert it into cash can fall in different quarters, and occasionally different tax years.
Acquisitions. If the startup is acquired, the treatment of stock options depends on the transaction terms:
- Cash Acquisition
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The acquirer purchases vested options for their cash spread (acquisition price minus strike price).
- Stock Acquisition
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Vested options are converted into options of the acquiring company, adjusted by the conversion ratio specified in the merger agreement.
- Mixed Acquisition
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Option holders receive a combination of cash and acquiring company stock.
Unvested options in an acquisition may undergo:
- accelerated vesting: Single-trigger (vesting upon the acquisition) or double-trigger (vesting only if the employee is terminated without cause within a specified window after the acquisition).
- Conversion: Substitution with the acquiring company’s unvested options.
- Cancellation: Forfeiture without compensation.
Expect not to be paid in full at closing. Acquirers routinely hold back a slice of the purchase price in escrow — market practice runs around 10%, for twelve to eighteen months — against indemnification claims, and may tie a further slice to your staying employed. Read the merger agreement for both. The money you are told you made and the money that reaches your account can be a year and a resignation apart.