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I've been trying to understand this hypothetical scenario wherein a company in which you own options is acquired. In it, the author posits you own .67% and 20,000 shares ($2 strike price, $4 share price) of a company that gets acquired for $50,000,000 and pays out about $5,000,000 to investors due to preferred stock terms, leaving $45,000,000.

I followed this scenario to this point, but then he says

you own 20,000 shares with a current share price of $4 per share, but you still have to buy these options to convert them to common stock. Your strike price is $2 per share, so you’ll have to cough up $151,196 to purchase the shares, which you will resell for $4 per share, getting you $151,196 in cash.

Here he loses me. I follow the percentages ($2 is 50% of $4 and 50% of .67% of $45M is about 150k) but I don't follow the share numbers.

  • Why would I not pay $2 per share, which was my strike price (total: $40k)
  • Are the shares not worth more than $4 since the acquisition?
  • By this math, if the investor hadn't increased the share price to $4 (i.e. if there was no new investor but the company was still acquired for $50M) what would have happened? It feels like my shares would be worth less, and that doesn't make a lot of sense to me.
  • 20,000 is 0.67% of (approximately) 2,985,075 shares. At $4/share, the total value was $11,940,300. After the sale, those same shares are now worth $45,000,000, for an adjusted share price of just over $15, and your strike price is presumably adjusted to retain the same 50% spread, to just over $7.50. 20,000 * 7.50 = $150,000, which is close enough to $151,196 that I assume the difference is due to rounding (that I didn't show) and the effect of the $5M to holders of preferred stock that I don't understand well enough to account for. – chepner Sep 20 '18 at 20:01
  • Is adjusting the strike price common? Let's assume the $4M investment never happened. In that world you had 20,0000 shares at $2 (1% of the original 4M value) and your strike price was $2 - i.e. no spread. If the strike price were adjusted after the acquisition you would gain no value and earn nothing. That sounds wrong. This document says the strike price is not adjusted during acquisitions schwab.com/public/file/P-3951800/INF57995_114923.pdf – Ben Sep 20 '18 at 20:22
  • $4/share is the price before the sale; the strike price is the price lower than the market price at which you have the option to buy a share. The incentive is that you get to buy the stock for less than it is worth, meaning you can sell it immediately for a profit. (Note that you are typically taxed on the spread, as the company is effectively giving you the extra $2/share you need.) – chepner Sep 20 '18 at 20:46
  • Note that you don't own any shares until you exercise the option; until then, you just have a right to buy the stock at the strike price. The option contract itself should probably specify what happens in the event of an acquisition. – chepner Sep 20 '18 at 20:54
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Why would I not pay $2 per share, which was my strike price (total: $40k)

This depends on how the options were worded. In the example it is assumed that the options will be repriced based on the new valuation ... so the $2 options now cost for $7.56 based on the valuation, hence you need to pay more for the options and not just $2.

This can be worded differently for different companies. i.e. in some companies, it can be at fixed $2 irrespective of any price. This was the practice in 2000's but has changed as more unicorns are floating around. Hence it is very important to read the options and how the pay out will be.

Are the shares not worth more than $4 since the acquisition?

Yes they are now worth around $15.12 and hence you will get around 302,293 for 20,000 shares.

  • So, when the options are granted in this scenario the text of the grant must have specified that the options will be set to 50% valuation? – Ben Sep 21 '18 at 21:21

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