Should you exercise your stock options before an acquisition?

You’re working at a startup that’s right 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 facing. 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 want to go public, and many founders start their startups with the expectation that they’ll grow them quickly, find product-market fit, and then sell them 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. On the other side of the table, 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. In some cases, that could mean cashless exercises for vested stock options, or a negotiated stock swap for unvested stock options in the acquiring company — where employees trade their stock options in Company A for stock options in Company B.

The acquiring company might simply pay out the employee stock option pool (both vested and unvested), turning those 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 those 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 major benefit to exercising stock options pre-exit is to take advantage of long-term capital gains. If it seems like the company is going to get acquired in under a year, the benefits of long-term capital gains are moot.

Want to learn more about stock options? Check out our educational resources at Secfi Learn.