What Happens to Stock Options and RSUs in an Acquisition

Introduction

When a company agrees to be sold, every employee who holds equity asks the same question: what happens to my options? The press release rarely says. The answer sits in the merger agreement and the company's equity plan, and it almost always resolves into one of four outcomes: the award is cashed out, converted into the buyer's equity, swapped for cash that keeps vesting, or cancelled.

For the buyer, those same awards are a cost. Every in-the-money option and restricted stock unit is a claim on the purchase price, so the offer price per share has to account for them, and executives' change-in-control packages can trip the US tax rules on golden parachutes.

What follows covers both seats at the table: how options, RSUs and PSUs are treated, single- and double-trigger acceleration, underwater options, how dilution feeds the price per share, Section 280G, and how a startup sale differs from a public-company deal. Filings from Microsoft's purchase of Activision Blizzard, the Twitter buyout and the Electronic Arts take-private show each mechanism in a real contract.

Equity awards do not follow a default rule. The equity plan sets what the board may do on a change of control, and the merger agreement records what the parties chose. Most deals mix the four treatments below, often paying vested awards in cash and handling unvested ones another way.

Cash-Out at the Spread

A cashed-out option pays the spread: the offer price minus the exercise price, times the number of shares, less tax withholding. An RSU has no exercise price, so it pays the full offer price per unit. Vested awards are the natural candidates, because the holder already owns the economic right and the buyer has no retention reason to keep it alive.

For an employee, a cash-out is usually taxed as ordinary compensation income rather than capital gain, and the withholding comes out before the money arrives. That surprises holders who expected to exercise later and hold the stock.

Assumption and Conversion at the Exchange Ratio

When the buyer has its own listed stock, it can assume the target's plan or grant substitute awards on the same terms. The conversion uses an equity award exchange ratio, usually the per-share cash offer divided by the buyer's average share price just before closing, so the award keeps its value.

Equity Award Exchange Ratio

The ratio used to convert a target company's employee stock options and RSUs into equivalent awards over the buyer's stock in an acquisition. It is typically the per-share offer price divided by the buyer's average share price over a short period before closing. The number of units is multiplied by the ratio and an option's exercise price is divided by it, which preserves the award's in-the-money value.

Take a $90 cash offer and a buyer whose stock trades at $300, a ratio of 0.30. An employee with 1,000 unvested RSUs receives 300 buyer RSUs worth $90,000. An employee with 1,000 options struck at $60 receives 300 options struck at $200 (60 divided by 0.30); the spread is $30,000 either way, (300 minus 200) times 300 against (90 minus 60) times 1,000. Stock-for-stock deals use the deal's own share ratio instead, with the mechanics covered in our breakdown of fixed and floating exchange ratios.

Cash Replacement Awards on the Original Schedule

A cash buyer taking a company private has no listed stock to hand out, so unvested awards are often turned into a fixed cash entitlement that vests on the old dates. When Elon Musk agreed to buy Twitter at $54.20 a share in April 2022, Twitter's employee FAQ, filed with the SEC, said each unvested RSU would become the right to $54.20 in cash, paid on the original vesting schedule if the employee kept working there.

The Electronic Arts take-private at $210 a share used the same device under a formal name, Replacement Cash Awards, which carried the replaced RSUs' and PSUs' vesting terms. The trade-off for employees is that the value is locked: a cash award does not rise if the business does well, and it no longer moves with any share price.

The three common award types carry different economics, so a merger agreement usually gives each its own paragraph. The questions differ too: options raise a strike price question, RSUs raise only a vesting question, and PSUs raise a performance measurement question that has to be answered before the performance period has finished.

Stock Options and RSUs

An option is worth only its intrinsic value, the spread, so its treatment depends on where the offer lands against the strike. A deep in-the-money option behaves almost like stock; one struck near the offer price is worth little; one struck above it is worth nothing at all. An RSU is a full-value award: every unit receives the whole offer price, which is why RSU-heavy companies carry more deal dilution per award than option-heavy ones.

PSUs and the Performance Question

A performance share unit pays out on a sliding scale, often 0% to 200% of a target number, depending on metrics measured over three years or so. A deal cuts that performance period short, and the agreement has to pick a number. The three common answers are target performance, actual performance measured to closing, or the greater of the two. Twitter's FAQ deemed unvested performance RSUs earned at target, while the EA proxy used the greater of target and actual performance measured shortly before closing.

Vested awards are the easy case. The holder has earned them, so they are paid in cash or converted at full value in almost every deal. Unvested awards are where the negotiation happens, because the buyer wants employees to keep earning their equity after closing and the employees would rather have it now.

Whether unvested equity vests early depends on acceleration provisions, which can sit in the equity plan, the award agreement or an executive's employment or severance agreement. They come in two forms.

Single-Trigger Acceleration

Under a single trigger, the change of control alone vests the award. The holder gets everything at closing, whether or not they stay. Single triggers are generous to employees and costly to buyers: the retention value of the unvested equity disappears on day one, so the buyer often has to pay again in new retention grants. They are more common for non-employee directors, who leave the board at closing anyway; the EA proxy, for instance, fully vested the directors' unvested RSUs at the effective time.

Double-Trigger Acceleration

A double trigger needs two events: the change of control and a qualifying termination within a protection window, usually a firing without cause or a resignation for good reason. If the employee keeps the job, vesting simply continues. Buyers and institutional investors prefer the structure because it protects people who lose their roles without paying people who keep them.

Double-Trigger Acceleration

A vesting provision under which unvested equity awards vest early only if two events occur: a change of control of the company and a qualifying termination of the holder's employment, typically a dismissal without cause or a resignation for good reason within a set period around the deal. A change of control on its own does not accelerate vesting.

EA's executives show the structure at work. The proxy quantified CEO Andrew Wilson's potential deal-related payments at $118,359,427, of which $105,933,240 was accelerated equity, and labeled that acceleration a double-trigger benefit payable only after a qualifying termination; our Electronic Arts take-private case study puts the figure in the context of the whole deal. Sponsors negotiate the same point with management in buyouts, covered in our guide to management equity incentives in an LBO.

An option whose exercise price is at or above the offer price has no spread to pay. In most public deals such options are simply cancelled for no consideration, as Activision's were. Employees sometimes expect a token payment, but the merger agreement owes them nothing unless it says so, and the holder could not have exercised profitably at the deal price anyway.

Underwater Option

A stock option whose exercise price is higher than the current share price or, in an acquisition, higher than the per-share offer price. Exercising it would cost more than the shares are worth, so it has no intrinsic value. In a merger, underwater options are usually cancelled without payment, though a buyer can choose to replace them with new awards.

Underwater options matter more in startup sales at a down valuation. If the price falls below the last funding round, much of the option pool can be underwater or sit behind the investors' liquidation preferences. Buyers that need the team usually solve the problem with new grants rather than paying the old options, and some sellers adopt a management carve-out plan that reserves part of the proceeds for employees whose equity would otherwise be worthless.

Treasury Stock Method at the Offer Price

The buyer pays for every share that will exist at closing, including shares that awards turn into. Bankers count them with the treasury stock method, run at the offer price rather than the current trading price: in-the-money options add shares net of the stock their strike proceeds could buy back, RSUs add their full count, and underwater options add nothing. Our explainer on how the treasury stock method builds a diluted share count covers the general method.

Take a target with 100 million basic shares, 5 million RSUs, 10 million options struck at $30 and 4 million struck at $60, and a bid of $50 a share.

Diluted shares are 100 million plus 5 million plus 4 million, or 109 million, and the equity purchase price is 109 million times $50, or $5.45 billion. The cash route gives the same answer: $5.0 billion for the shares, $250 million for the RSUs and $200 million of option spread (10 million times $20). The $60 options are underwater and cost nothing.

What Each Extra Dollar of Price Costs

The marginal cost of a price bump is the more useful number in a negotiation. Raising the bid from $50 to $51 costs $115 million, not $100 million, because 115 million securities share in each dollar: the basic shares, the RSUs and every in-the-money option. Above $60, the second option tranche comes into the money and each further dollar costs $119 million. This is the dilution cost a board weighs when it asks for one more dollar, and it is why the stock-based compensation a target has issued over the years ends up in the price.

The Circularity in a Fixed-Price Deal

Startup acquisitions are often agreed as a single aggregate equity value split across every share and option. That creates a circularity: the per-share price depends on how many options are in the money, and which options are in the money depends on the price. When in-the-money options are cashed out at the spread, the price solves directly:

Say a buyer pays $500 million for a company with no debt or preferred stock, 40 million shares, 10 million options at $5 and 5 million options at $20. Including every option gives (500 + 50 + 100) / 55, about $11.80, which is below the $20 strike, so that out-of-the-money tranche cannot share in the proceeds. Dropping it gives (500 + 50) / 50 = $11.00. The check holds: 40 million times $11 is $440 million, plus 10 million times the $6 spread is $60 million, for $500 million. Run as a treasury stock method share count at $11, the same result appears: about 45.5 million diluted shares times $11.

Equity award dilution is a classic M&A pricing question: Interviewers ask how a bid of a few dollars more changes the diluted share count and the purchase price, start practicing interview questions for free and work through treasury stock method and offer-price questions until the arithmetic is quick.

Deal-related payments to executives, including severance, bonuses and accelerated equity, can fall under Section 280G of the Internal Revenue Code. The rule targets payments that are contingent on a change in ownership or control and go to a disqualified individual: an officer, a shareholder or a highly compensated individual.

Section 280G (Golden Parachute Rule)

A US tax rule that penalizes large change-in-control payments to a company's officers, shareholders and highly compensated individuals. If the present value of such payments equals or exceeds three times the individual's base amount (average annual taxable compensation over the previous five years), the company loses its deduction for the excess over one times the base amount, and the recipient owes a 20% excise tax on that excess under Section 4999.

The Three Times Base Amount Cliff

The base amount is the individual's average annualized includible compensation over the most recent five taxable years before the change in control. Under Section 280G, payments become parachute payments once their present value equals or exceeds three times that figure, and the excess parachute payment is everything above one times the base amount. Accelerated vesting counts as well, though the Treasury regulations can value some acceleration at less than the full award.

The threshold works as a cliff. Take an executive with a base amount of $1 million:

Excise Tax, Cutbacks and Gross-Ups

Companies handle the cliff in three ways. A best-net cutback reduces payments to just below the threshold whenever that leaves the executive better off after tax. In the example, assuming a 40% combined income tax rate, taking the full $3.5 million nets $1.6 million after the excise tax, while being cut back to just under $3 million nets about $1.8 million, so the cutback wins.

A gross-up goes the other way: the company pays the executive enough to cover the excise tax and the tax on the gross-up itself. Because the gross-up is also an excess parachute payment, covering a $500,000 excise tax at those rates costs about $1.25 million, all of it nondeductible.

That expense is why proxy adviser ISS has for more than a decade treated excise tax gross-ups in new or extended agreements as a problematic pay practice. EA's change-in-control plan carried a best-net cutback, and its merger proxy said the company could also enter into make-whole agreements with executives hit by the excise tax, capped at $50 million in aggregate, though none had been signed.

The Private-Company Shareholder Vote

Private companies have an exit that public ones do not. Section 280G exempts companies that could have elected S corporation status, and companies with no readily tradeable stock if the payments are approved by holders of more than 75% of the voting power after adequate disclosure. Under the Treasury regulations, shares held by the disqualified individuals receiving the payments are excluded from the count, and the vote must actually decide whether they get paid: deal approval cannot be conditioned on it. In practice, executives sign waivers giving up the excess payments unless shareholders approve them, which is why a 280G vote is a routine step in many venture-backed sales.

Golden parachutes and equity awards turn up in M&A technicals: The 160-page PDF covers merger models, accretion and dilution, diluted shares and deal structuring with worked examples, access the IB Interview Guide and connect the purchase price to every claim that sits inside it.

Why Buyers Grant New Equity

Cashing out or accelerating old awards removes the reason for key people to stay, so buyers often set aside a retention pool of new awards vesting after closing. These grants are not part of the purchase price. When Facebook agreed to buy WhatsApp in 2014 for about $16 billion in cash and stock, it announced an additional $3 billion of restricted stock units for WhatsApp's founders and employees, vesting over four years after closing.

The accounting follows the same logic. For replacement awards, the part attributable to service before the deal counts as purchase consideration, while the part tied to service after closing is expensed as post-combination compensation, as our accounting guide explains in its section on how acquisitions split replacement awards. New retention grants are entirely post-combination expense, which is why a large acquisition can lift the buyer's stock compensation for years.

Retention in Sponsor-Backed Deals

A private equity buyer handles retention differently. Existing awards are usually cashed out or rolled over at closing, and the sponsor then creates a fresh management incentive pool sized as a share of the new equity, often options or profits interests that pay only if the sponsor's investment grows. For a banker modeling the buyout, that means two separate items: the one-time cost of buying out old awards in the uses of funds, and the ongoing dilution from the new pool at exit.

Public Company Deals

In a public deal, award treatment is negotiated between the board and the buyer, written into the merger agreement and disclosed in the merger proxy or tender offer documents. Employees do not vote on their own awards, and every holder of a given award type is treated alike. Shareholders cast a separate, non-binding say-on-golden-parachute vote on executives' deal-related pay, but the company is contractually bound to pay whatever the result. The award cost is visible: bankers can rebuild the diluted share count from the proxy's tables at the offer price.

Private Startup Deals

Startup sales add features that rarely appear in a public deal:

Unvested options in a startup sale are often assumed or replaced by the buyer, because the founders and engineers are much of what the buyer is paying for. Vested options are usually cashed out net of the strike price, a net settlement that spares the holder from finding cash to exercise before closing.

Candidates and employees make the same handful of errors, and most come from treating every award the same way:

Equity awards look like a footnote to the headline price, but they decide how much of that price reaches employees and how much the buyer actually pays. The merger agreement sets the outcome award by award, and a few filings, Activision's, Twitter's and EA's among them, show nearly every treatment in practice.

For an employee, the important documents are the award agreement, the plan and any severance letter, read before signing day rather than after. For a banker, the job is to count every claim at the offer price, price each extra dollar of bid against the diluted share count, and put parachute payments and retention grants in the deal cost.

In an interview, the strongest answer joins both views: what the holder receives, what it costs the buyer, and why the acceleration terms shape both.