What Happens to Unvested Options in the Case of an Exit Event?

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Table of Contents

• What is an ESOP?
• What are Options and Vested Options?
• What Happens to Unvested Options in Case of an Exit Event?
• Key Takeaways
• Frequently Asked Questions

In July 2015, the Australian Government introduced startup tax concessions for employees under certain remuneration schemes, like Employee Share Option Plans (ESOPs). Under these tax incentives, eligible startups can offer their employees, contractors or directors an ownership stake in the company on tax-favourable terms. Options are a right to purchase shares in the future after a specified time. If an employee does not fulfil these conditions, the options are known as unvested options. This article will discuss what happens to unvested options if founders and investors in a company decide to sell the company.

What is an ESOP?

An Employee Share Option Plan (ESOP) is a scheme that provides employees with an ownership interest in the company by giving them company options. Options are a right to acquire shares in the company at a specified time so long as the employee meets certain vesting conditions. Common vesting conditions include time-based vesting, which ties the receipt of shares to the employee’s service at the company, thus incentivising the employee to stay on board and contribute to the company’s success.

What are Options and Vested Options?

When employees receive options under an ESOP, they receive a right to buy shares in the company for an agreed price (also known as the “exercise price” or “strike price”) at a specified time in the future. When employees exercise their options, they convert their options into shares. Under an ESOP, employees can only exercise options once they have met the requisite vesting conditions for those options. Until an employee meets the vesting conditions, they hold unvested options.

An employee holding vested options is deemed, at law, to be the full legal and equitable owner of those options. Therefore, vested options have value. Upon an exercise event, vested options convert into shares upon payment of the exercise price.

What Happens to Unvested Options in Case of an Exit Event?

An exit event is when the owners of a company “exit” the business by selling the business. The three main methods of exiting are either by:

• listing the company (Initial Public Offering);
• selling substantially all of the assets of the company; or
• selling substantially all of the shares of the company.

The treatment of unvested options upon an exit event will differ depending on the individual plan rules governing the company’s ESOP and any other constituent documents which govern the company. Under the plan rules, the Board has the discretion to decide what happens at an exit event.

Most commonly, any unvested options will have their vesting accelerated (i.e. the company waives vesting conditions), allowing option holders to participate and benefit from the sale. Alternatively, the Board may decide to buy back or cancel the options at their fair market value.

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Key Takeaways

Companies often use option plans to retain key talent and provide employees with a long-term incentive to stay with a company. When the owners of a company exit the business by selling the company, the board of directors will either buy back or cancel unvested options at their fair market value or allow the outstanding options to vest.

If you have any questions about ESOPs or the vesting of options, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions