The acquisition closes. The press release goes out. Everyone says congratulations. And then the question that every founder, employee, and investor actually wants answered: what happens to my equity?

The answer depends on how the deal is structured, what class of stock or options you hold, whether your equity is vested, and what the acquisition agreement says about each of these things. This post walks through the four most common scenarios and what they mean for the people holding equity.

Scenario 1: All-Cash Acquisition

The simplest scenario. The buyer pays cash for the company, and all outstanding equity is converted to the right to receive a specified amount of cash per share.

The key concept is the liquidation waterfall — the order in which the proceeds are distributed. Preferred stockholders (investors) receive their liquidation preferences first. If the preferred is non-participating, they choose between taking their preference amount or converting to common and taking their pro-rata share of the proceeds. If the preferred is participating, they take their preference amount first and then participate alongside common stockholders in the remaining proceeds.

After all preferred claims are satisfied, common stockholders — founders and employees — receive their pro-rata share of whatever remains. In a large enough deal, everyone does well. In a deal where the purchase price is close to or below the total liquidation preference stack, common stockholders may receive little or nothing.

Option holders receive the difference between the per-share acquisition consideration and their exercise price. An option with a $0.50 exercise price in a deal paying $5.00 per share is worth $4.50 per share. An option with a $6.00 exercise price in the same deal is underwater — worth nothing, because the cost to exercise exceeds the price received. Underwater options receive no consideration.

Tax treatment for common stockholders in a cash deal: capital gain on the difference between the proceeds received and the cost basis in the shares. Long-term capital gain rates apply if the shares were held for more than one year from the date of acquisition (which, for founders who filed an 83(b) election, is measured from the grant date, not the vesting date).

Scenario 2: Stock-for-Stock Acquisition

Instead of cash, shareholders receive stock of the acquiring company. A merger in which Company A acquires Company B and Company B's shareholders receive Company A shares is a stock-for-stock transaction.

The significant advantage of a properly structured stock-for-stock transaction is tax deferral. If the merger qualifies as a tax-free reorganization under Section 368 of the Internal Revenue Code — which requires, among other things, that the consideration consist primarily of acquirer stock — then selling shareholders do not recognize gain at the time of the merger. They take a carryover basis in the acquirer's shares and recognize gain only when they sell those shares.

This is a substantial benefit when the selling shareholders have a low basis in their stock (which is typical for founders who bought shares at $0.001 per share). Instead of paying capital gains tax at closing, they defer that tax until they actually liquidate the acquirer's shares — potentially years later.

The obvious risk: the acquirer's stock must be worth what you think it is worth, and that value can change. Taking stock in a public company is one thing — you can sell it in the market after any applicable lockup period expires. Taking stock in a private company is another — the shares may be illiquid for years, and if the acquirer's business deteriorates, the value of the consideration you received may decline.

Scenario 3: Mixed Consideration

Many acquisitions involve a combination of cash and stock — part of the purchase price is paid in cash at closing, and part is paid in acquirer stock. This is sometimes called a "mixed consideration" deal.

The tax treatment is more complex than either a pure cash or pure stock deal. The cash component is taxable immediately. The stock component may qualify for tax-free reorganization treatment (deferral) if the overall transaction structure meets the applicable tests. The allocation between taxable and non-taxable consideration must be calculated carefully, and the tax consequences to each individual shareholder depend on their basis in their shares and their holding period.

In a mixed consideration deal, do not assume you can make decisions about your individual tax treatment without specific advice from a tax professional who has seen the actual deal documents. The mechanics are highly fact-specific.

Scenario 4: Earnouts

Earnouts are contingent consideration — a portion of the purchase price that is paid only if the company (or a specific product line or business segment) hits defined performance targets after closing. Earnouts are most common in situations where buyer and seller have different views on the company's value, or where future value is heavily dependent on milestones that have not yet been achieved.

In evaluating what an earnout is worth, the most important thing to understand is that you will not control the business after closing. The acquirer does. Their decisions about pricing, sales force allocation, product investment, and marketing directly affect whether the earnout metrics are achieved — and their obligation to maximize earnout achievement (if any) is only as strong as the specific covenant language in the acquisition agreement.

Without a clearly drafted obligation to operate the business in good faith for earnout achievement, you are at the mercy of the acquirer's business priorities. Earnout disputes are among the most common forms of post-closing litigation in M&A. Treat earnout consideration as worth significantly less than face value — some practitioners apply a 25–50% discount as a rule of thumb for modeling purposes, depending on the earnout structure and the acquirer's incentives.

What Happens to Unvested Equity

Unvested shares, unvested options, and other unvested equity can be treated in three ways in an acquisition — and which treatment applies depends entirely on what is negotiated in the acquisition agreement:

  • Assumption. The acquirer assumes the unvested equity and converts it into unvested equity in the acquirer on similar terms. Vesting continues according to the original schedule (or a new schedule negotiated at closing). This is the most common outcome for employees in most acquisitions and is generally the acquirer's preferred approach, because it maintains retention incentives.
  • Acceleration. The unvested equity vests at closing — either fully or partially. This is triggered by acceleration provisions in the equity agreements (see our post on founder vesting and single- vs. double-trigger acceleration). Full acceleration at closing (single-trigger) immediately vests everything; partial acceleration may vest some percentage upon closing with the remainder continuing under the original or a new schedule.
  • Cash-out at the acquisition price. Some acquisitions cash out all equity — vested and unvested — at the per-share acquisition consideration. This is most common in straightforward cash deals where the acquirer does not want to issue its own equity or maintain ongoing vesting obligations.

If you are a founder or key employee with meaningful unvested equity, the treatment of that equity is one of the most important points to negotiate before signing the LOI — not after the definitive agreement is in draft.

Escrow and Holdback: The Money You Don't Receive at Closing

In almost every private company acquisition, a portion of the purchase price — typically 10–15% — is held in escrow for a period of 12–18 months after closing. This escrow secures the seller's indemnification obligations: if the buyer discovers post-closing that a representation in the acquisition agreement was inaccurate, they can make a claim against the escrow rather than chasing individual stockholders for repayment.

The practical implication: you do not receive the escrow amount at closing. You receive it — if there are no indemnification claims — when the escrow period expires. If claims are made, the escrow may be reduced by the amount of those claims.

Representation and warranty (R&W) insurance has changed this dynamic significantly in recent years. When R&W insurance is in place, the buyer claims against the insurance policy rather than the escrow for most breaches, which allows escrow amounts to be reduced or even eliminated in some deals. Founders negotiating an acquisition should ask whether R&W insurance is contemplated as part of the deal structure.

A Note on Option Tax Treatment

For employees holding incentive stock options (ISOs), the tax treatment in an acquisition depends on whether the sale qualifies as a "qualifying disposition" — which requires the employee to hold the shares for at least two years from the date of the option grant and at least one year from the date of exercise. A qualifying disposition produces long-term capital gain on the spread between the exercise price and the sale price.

A stock acquisition that causes ISOs to be cashed out before these holding periods are met produces a "disqualifying disposition" — the spread between the exercise price and the acquisition price is taxed as ordinary income. This is an important planning consideration for employees who exercised options recently before an acquisition announcement.

The Bottom Line

The economics of an acquisition are not determined by the headline price. They are determined by the liquidation waterfall, the consideration structure, the treatment of unvested equity, the earnout mechanics, the escrow terms, and the tax treatment of each category of equity holder.

Do not wait until the acquisition announcement to understand these mechanics. Know your cap table, your vesting schedule, your option strike prices, and your liquidation preference stack before a deal is ever on the table. When the term sheet arrives, you will be in a position to evaluate what it actually means — not just what the headline number says.