Sometimes, people like to refer to stock options as Monopoly money. It’s fun to dream about what they could buy, but you can’t usually convert them to cash (and buy real houses) unless you get lucky and your company goes public or gets acquired.
Fortunately, this is changing. Even though companies are staying private longer, many are exploring ways to offer their employees liquidity.
A common liquidity option is the tender offer. Here’s what you need to know.
What is a tender offer?
A tender offer is a structured, company-sponsored liquidity event that typically allows multiple sellers to tender their shares either to an investor or back to the company. In other words, it’s a potential way for you to sell some of your shares while your company is still private.
Tender offers can benefit everyone involved:
- The sellers (you, other employees, and early investors) monetize their equity without having to wait for the company to go public or get acquired.
- The buyer receives equity in a company they’d like to invest in.
- The company attracts and retains talent, as employees value the opportunity to receive cash for their stock and options as the company matures.
What are the different types of tender offers?
There are two types of tender offers used in this context:
- Issuer tender offers, also known as share buybacks, are when the company offers to buy shares back from shareholders.
- Third party tender offers are when an investor or company offers to buy shares.
How do tender offers work?
The details can vary, but in general, the tender offer process looks something like this:
A buyer offers to buy shares at a set price. This offer isn’t guaranteed—they usually require a specific minimum amount of shares, so there has to be enough interest. Otherwise, they may not be obligated to go through with the offer. To encourage people to sell sufficient volume to meet their needs, they sometimes offer a price that is at a higher end of the valuation for the shares.
Once the company confirms the offer price and gets approval from the board of directors, they work with their counsel and the buyers to prepare the disclosures and transaction documents.
Finally, a window is opened for you as a seller to evaluate the transaction details and decide whether you want to participate, and if so, how many shares you want to sell. Under SEC rules, tender offers must remain open for at least 20 business days, so you have time to ask questions, examine the documents, and decide whether participating is right for your personal circumstance. Your company must provide financial statements as part of the transaction disclosures, so you can make an informed decision about selling.
Tender offer rules and regulations
Companies will often set qualifying criteria for participating in a tender offer. Sometimes, your company might only allow you to participate if you’ve exercised your options and held the resulting stock for at least six months. They might also limit how many shares you can sell to ensure your incentives are aligned with the company.
Tender offer example
- Krakatoa Ventures offers to buy at least 2,000,000 shares, or 5%, of Meetly common stock
- Fair market value (FMV) of Meetly stock prior to the tender offer: $15
- Krakatoa Ventures offers $17 per share
- The offer lasts for 20 business days
Should you participate in a tender offer?
Ultimately, participating in a tender offer is a personal decision. Here are a few tips to help you decide:
- Go to the info sessions. There, you can ask questions and get the important details, like who qualifies and when you have to decide by.
- Read all the documents your company gives you. They should help you get a better idea of how your company is doing.
- Talk to a financial advisor. They can help you figure out if it’s a good idea to participate in the context of your current financial situation and goals.
Also, ask yourself the following questions:
- What are my financial goals? Do I need the money now, or can I wait?
- How’s my company doing? Do I think the value of my stock will continue to rise?
- When do I think the next liquidity event will be?
- How much will it cost to exercise my remaining stock options?
- Do I think the price the buyer is offering is fair?
Pros and cons of participating in a tender offer
What happens if you don’t accept a tender offer?
You don’t have to participate in a tender offer. If you’d rather keep your shares, simply don’t do anything.
How are tender offers taxed?
If your company lets you exercise options and sell the resulting shares in one transaction (and you choose to go that route), you’ll pay ordinary income tax on the difference between your strike price and what the shares are worth when you exercised and sold them. Keep in mind that if you make enough profit, this extra income could bump you up into a higher tax bracket.
If you tender shares you already own (e.g., shares from exercised options or settled RSUs), you’ll pay capital gains taxes on any increase in the value of the shares between the exercise price and the sale price.
- If you’ve held the shares for at least one year after exercising and two years after your grant date, you’ll pay long-term capital gains.
- If you sell before you hit the holding period mentioned above, you’ll pay short-term capital gains.
Tender offer example (continued)
- You exercised 500 shares from your ISO at a $5 strike price over a year ago. You received your grant more than two years ago. The FMV of the shares was $10 when you exercised.
- Your company allows you to sell up to 10% of your 500 shares
- You decide to sell 50 shares in this tender offer, which gets you $850 ($17 offer price * 50 shares)
- You will pay long term capital gains on $600 [ ($17 offer price – $5 strike price) x 50 shares]
If you want to optimize your tax withholding strategy, lowering your adjusted gross income by maxing out your 401(k) and increasing charitable donations may help. You should also consult with a tax professional before participating.
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