One might assume that a public company’s acquisition of another business would be a drain on that company’s equity plan share reserve because of conversion of the target company’s equity awards into awards based on the acquiror’s stock or new grants to target employees. But that is not necessarily the case. Several exemptions are available under the stock exchange listing rules that avoid the requirement for shareholder approval, and can, in certain circumstances, help avoid an M&A-related drain on the acquiror’s equity plan share reserve.

Technical Points

There are two M&A-related exemptions to the general NYSE and NASDAQ listing rules that require compensatory equity grants be made pursuant to shareholder-approved equity plans (i.e., NYSE Listing Company Manual Rule 303A.08 and NASDAQ Listing Rule 5635(c) and IM-5635-1).

First, the share reserve under a preexisting shareholder-approved target equity plan may be used for post-transaction grants without additional shareholder approval under certain circumstances. Shares available under such a preexisting plan may be used for post-transaction grants of acquiror equity awards (assuming the acquiror remains a publicly-traded company), under either the preexisting target equity plan or another plan (such as the acquiror’s equity plan), without further shareholder approval, under the following conditions:

  1. The shares must be available under a plan that was not adopted in contemplation of the M&A transaction.
  2. The number of shares available for grants is appropriately adjusted to reflect the M&A transaction.
  3. The time during which those shares are available for grant is not extended beyond the period when they would have been available under the preexisting plan absent the M&A transaction.
  4. The equity awards are not granted to individuals who were employed, immediately before the transaction, by the acquiror and such grants are therefore generally limited to grants to employees of the target and its subsidiaries who continue employment with the acquiror post-transaction.

Second, shareholder approval is not required (and thus no automatic reduction in the acquiror’s equity plan share reserve) to convert or replace outstanding target equity awards to awards denominated in shares of acquiror stock to reflect the merger or acquisition. An acquiror considering taking advantage of this exemption should keep the following in mind:

  1. This exemption covers both assumptions and substitutions of target equity awards.
  2. If the acquiror’s equity plan contains a provision calling for converted or substituted awards to count against the share reserve, then the share reserve would need to be reduced.
  3. Relevant terms of the equity plans should be reviewed, including as to participant consent relating to the assumption and substitution of awards.
  4. A Form S-8 may be required in connection with the assumption or substitution of equity awards, the timing of which will depend on the type of equity being assumed or substituted.
  5. Special care should be taken that the substitution of any equity awards does not convert an option intended to qualify as an incentive stock option into a nonqualified stock option or result in a violation of Section 409A of the Internal Revenue Code.

Note that any shares reserved for listing in connection with an M&A transaction pursuant to these exemptions may be counted by the applicable listing exchange in determining whether the transaction involved the issuance of 20 percent or more of the listed company’s outstanding common stock and thus might require shareholder approval under other exchange listing rules.