Treatment of company options: Overview, definition, and example
What is the treatment of company options?
The treatment of company options refers to the way stock options issued by a company are managed, accounted for, and exercised, particularly in the context of mergers, acquisitions, or changes in company structure. A company option typically gives an employee, director, or other stakeholder the right to buy a specific number of shares of the company’s stock at a predetermined price (the "exercise" or "strike" price) within a certain time period.
The treatment of these options may involve different decisions regarding their exercise, cancellation, or modification depending on the circumstances of a corporate transaction, such as a sale, merger, or restructuring. This treatment determines whether the options remain in effect, are cashed out, converted into options for the acquiring company’s stock, or become void.
Why is the treatment of company options important?
The treatment of company options is important because it impacts both the employees holding the options and the company’s financial obligations. For employees, the outcome of how their options are treated in a transaction can significantly affect their financial standing. They may benefit from the opportunity to exercise options at a favorable price, or they may lose out if the options are not honored.
For the company, properly handling the treatment of options ensures compliance with financial regulations, minimizes disputes, and provides clarity during transactions. It also affects the company's balance sheet, as stock options represent a potential dilution of ownership, which must be accounted for when making decisions about their treatment.
Understanding the treatment of company options through an example
Imagine a company, TechCo, that issues stock options to its employees as part of their compensation package. TechCo is later acquired by another company, InnovateInc. In the acquisition agreement, the treatment of the outstanding options is addressed:
- Cash-out: Employees may be allowed to "cash out" their options, meaning they can receive a cash payment for the difference between the exercise price and the acquisition price per share.
- Conversion: Alternatively, the options could be converted into options for InnovateInc’s stock at an adjusted price based on the acquisition terms.
- Acceleration: In some cases, the options may become fully vested and exercisable immediately upon the acquisition, known as "acceleration," allowing employees to exercise them before the merger closes.
In the case of a merger, the treatment of company options will depend on the terms negotiated between the acquiring company and the target company. If the options are "underwater" (i.e., the exercise price is higher than the current market price), the acquirer might choose to cancel those options.
Example of treatment of company options clause
Here’s what a treatment of company options clause might look like in an acquisition agreement:
“In the event of a Change of Control, all outstanding stock options granted under the Company’s Option Plan shall be treated as follows: (a) all unvested options will immediately vest, (b) the options will be cashed out at the difference between the exercise price and the per-share acquisition price, or (c) the options will be converted into options for the acquirer’s stock at an adjusted price, subject to the terms outlined in the Change of Control Agreement.”
Conclusion
The treatment of company options is a crucial aspect of corporate transactions, particularly mergers, acquisitions, or restructurings. The way stock options are handled can impact employees’ financial outcomes and the company's obligations, making it essential for both parties to agree on clear terms regarding the treatment of these options.
For employees, understanding the treatment of their options helps them make informed decisions about their financial future in the context of a transaction. For companies, carefully managing the treatment of options ensures compliance, fairness, and clarity throughout the corporate transaction process.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.