Change of Control Vesting Acceleration

I am a big fan of change of control option vesting acceleration, particularly for the executive team.  I am probably not in the majority of VCs on this topic.    Quick background:

1.  Normally employee options vest over 4 years, with 25% vesting after year 1 and then the balance pro rata (monthly or quarterly) over the remaining 3 years.

2.  When a VC prices an investment transaction, it normally treats all options as “outstanding” for purposes of determining the number of shares outstanding (in order to divide into the pre-money valuation to determine a share price).

3.  Often times with an executive, he will bargain for change of control vesting acceleration, meaning that on a sale of the company, his vesting accelerates so that he can exercise all his options (if they are in the money) immediately prior to the sale event and “score” a larger return in the sale event (shareholders get paid in a sale event, and if you own more shares you get more $$).

4.  Typically, a company’s stock option plan will provide that if options are NOT assumed by the acquiring company that they accelerate and then terminate if not exercised immediately prior to the sale event.  This allows the acquiror to NOT be burdened with employee options of the selling company.  Note that if the acquiror so chooses to assume the options (and the assumption terms are up to the boards to agree on and very flexible), then they do not accelerate.   This allows the acquiror to fold in the new employees into the its company on option terms that line up well with its existing employee base.

5.  Going public does NOT equal a change of control.  No acceleration on going public.

So, personally, I like vesting acceleration on a change of control for the executive team.  Last I checked, we VCs love it when a portfolio company is sold for a tidy profit.  And we VCs know that a sale is not possible without the management team making an incredible effort.  And we know that the options will be worthless unless our liquidation preferences are cleared.  So, let’s reward the team for a job well done – accelerate the options and let them participate to a greater extent.  After all, we treated those options as outstanding when we originally priced our investment…….

Also, I like simple.  Single trigger acceleration is simple, with the trigger being the change of control itself.  Double trigger is tricky to implement.  With double trigger acceleration the 2 triggers required are (i) the change of control and (ii) the executive being fired without cause or leaving for good reason within a set period of time (often 1 year) after the change of control.  I have never seen double trigger provisions implemented easily for the following reason – if the second trigger is tripped, and the executive’s options in the acquired company accelerate, what does the executive get?  Typically, the acquired company is gone and its shareholders have been paid in the acquisition.  Where would the funding come from to compensate the executive for the value of his exercised options?  Not from the already paid former shareholders.  This is a challenging problem and one that I don’t like to create.

Finally, I have also seen plenty of situations where an executive’s options accelerate 50% (or some other %) on a change of control, which means that 50% of the unvested options would accelerate.   That is fine and easy to implement.  This is particularly useful if you don’t want to bestow a windfall on an executive that has not been with the company for a subtantial time period prior to the change of control.  For example, the vesting provisions could provide for 50% acceleration if the executive has been with the company for less than 2 years, 75% acceleration for between 2 and 3 years and 100% if greater than 3.  That progressive acceleration is still simple to implement.

Bottom line:  I like acceleration for executives and like to keep it simple and understandable.

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3 thoughts on “Change of Control Vesting Acceleration

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