Should you exercise your stock options before an acquisition?

You’re working at a startup that’s about to be acquired. Should you exercise your vested stock options now, or wait until the sale is complete?

Short answer: It depends on the type of acquisition your company is undergoing. Every situation is unique, so check with a CPA before making decisions one way or another.

Acquisitions can be an exciting and positive outcome for a startup. Not all startups aim to go public. Many founders build their companies with the goal of scaling quickly, achieving product-market fit, and selling to a larger competitor. When they do, founders will try to negotiate the highest possible price for their startup, arguing for their company’s momentum, traction, and the strength of its offering. Meanwhile, the acquiring company will negotiate for the lowest possible price they can, and the two parties usually meet somewhere in the middle.

In those negotiations, your startup’s founder may negotiate for what to do with the employee stock option pool. This could mean cashless exercises for vested stock options, or a negotiated stock swap for unvested stock options — where employees exchange their stock options in Company A for stock options in the acquiring Company B.

The acquiring company may also choose to cash out the employee stock option pool, converting both vested and unvested shares into cash.

If the acquiring company is publicly traded, it might offer its own publicly traded stock in return for the private shares in the startup’s equity pool.

During negotiations, the startup being acquired will likely enter a blackout period where they won’t be able to tell employees what’s happening behind closed doors.

For employees who hold stock options, the major risk is that the acquisition will be worse than expected, and they’ll lose money. If the startup gets acquired at fire sale prices, preferred shareholders (i.e. investors) can jump to the front of the line to recoup their costs. Anything left over gets distributed to common shareholders (i.e. employees).

If your startup is entering acquisition negotiations, it can be financially prudent to simply wait to see how the acquisition shakes out.

The primary potential advantage of exercising stock options before an exit is qualifying for long-term capital gains treatment if exercised shares are held longer than one year.. If it seems like the company is going to get acquired in under a year, the benefits of long-term capital gains are moot.