Your Startup Is Getting Acquired. Here's What Actually Happens to Your Equity.

You just found out your company is being acquired. Maybe you’ve known for weeks, maybe you got the all-hands invite this morning. Either way, one thing is suddenly very clear: the equity you’ve been accumulating—those ISO grants, the shares you early-exercised, that vesting schedule you stopped thinking about—is about to become real money.

And with real money comes real taxes.

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This is the moment when friends start throwing around terms like QSBS, AMT, and “holding strategy.” When well-meaning colleagues forward articles about tax-free exits. When you realize that decisions you made years ago—or didn’t make—now determine whether you keep 60% of your payout or 85%.

This guide won’t make you a tax expert. But it will help you understand what’s actually happening, which questions to ask, and how to think clearly about decisions that are often irreversible.

First: Separate Your Equity Into Buckets

Before you can understand the tax implications, you need to know what you actually have. In most acquisition scenarios, startup employees hold some combination of these:

Already-exercised shares. If you exercised your ISOs—whether recently or years ago—you now own actual stock. These shares have their own tax history, their own QSBS eligibility (or lack thereof), and their own clock.

Unexercised options. These are still contracts, not stock. They give you the right to buy shares at a fixed price, but you haven’t done so yet. The acquisition will force a decision about what happens to these.

Retention grants (often RSUs). If the acquirer wants you to stay, they’ll often offer new equity in their company. This is completely separate from your existing startup equity and follows its own tax rules.

Each bucket is taxed differently. Mixing them up is where people make expensive mistakes.

QSBS: The Massive Tax Break You May (or May Not) Have

Qualified Small Business Stock (QSBS) under Section 1202 is one of the most valuable tax benefits in the entire code. If your shares qualify, you can potentially exclude up to 100% of your federal capital gains—up to $10 million for stock issued before July 5, 2025, or $15 million for stock issued after that date.

On a $5 million gain, that’s roughly $1.2 million in federal taxes you simply don’t owe.

But here’s what most people miss: QSBS eligibility is determined lot by lot. Each time you exercised options, you created a separate lot with its own eligibility. Some of your shares may qualify. Others may not. And you cannot make non-qualifying shares qualify by wishing it were so.

The Core QSBS Requirements

For any lot to qualify for QSBS, all of the following must be true:

1. C-Corporation status. The company must have been a domestic C-corp when your shares were issued. If it started as an LLC and converted later, only shares issued after conversion can qualify.

2. Gross assets test. At the time your shares were issued, the company’s aggregate gross assets must have been $50 million or less (now $75 million for shares issued after July 4, 2025). This is tested at each issuance date—meaning your 2019 exercise might qualify even if your 2024 exercise doesn’t.

3. Active business requirement. At least 80% of the company’s assets must be used in an active qualified trade or business. Most tech companies satisfy this. Law firms, consulting shops, and financial services companies typically don’t.

4. Original issuance. You must have acquired the shares directly from the company, not purchased them from another shareholder. ISO exercises count as original issuance. Secondary purchases generally don’t qualify.

5. Holding period. You must hold the shares for more than 5 years. For stock issued after July 4, 2025, new rules allow partial exclusions: 50% if held 3+ years, 75% if held 4+ years, and 100% if held 5+ years. For older shares, it’s still all-or-nothing at the 5-year mark.

California Doesn’t Care About Your QSBS

If you live in California, here’s the cold reality: the state does not conform to Section 1202. Your QSBS-eligible gain that’s federally tax-free is still fully taxable by California at rates up to 13.3%. On that $5 million gain, you might owe zero federal tax and $665,000 to California. This catches people off guard. Plan for it.

If You Already Exercised: What Happens at Close

For shares you already own, the key question is simple: how does the acquisition treat them?

All-cash acquisition. Your shares are converted to cash at the deal price. This is a sale. You recognize gain (or loss), and QSBS applies to qualifying lots. There is no “holding strategy” here—you’re selling whether you want to or not.

Stock-for-stock or rollover. You receive shares in the acquiring company instead of (or in addition to) cash. This is where things get complicated. The tax treatment depends on deal structure, and QSBS may or may not carry over. You’ll need professional guidance here.

Earnout or deferred consideration. Part of your payout is contingent on future milestones. The tax timing and character of these payments can get complex.

The practical reality: in most acquisitions, you don’t get to cherry-pick which shares to sell. All shares typically convert at closing. The planning question is whether any structural flexibility exists to preserve or optimize tax treatment.

Unexercised Options: The Decision You’re About to Be Forced to Make

If you have ISOs or NSOs that you haven’t exercised, the acquisition will force one of these outcomes:

Cash-out at close. Your vested options are automatically converted to cash (deal price minus strike price). This is treated as compensation income—ordinary tax rates, W-2 reporting, payroll withholding. No QSBS. No capital gains treatment. This is the most common outcome.

Assumption or conversion. Your options are converted into options or RSUs in the acquiring company. You don’t recognize income at close; the tax event is pushed forward.

Exercise window. Some deals give you a short period (often 30-90 days) to exercise options post-close. If you don’t exercise, they expire worthless.

What About AMT?

AMT (Alternative Minimum Tax) is the specter that haunts ISO holders. When you exercise an ISO and hold the shares, you may owe AMT on the spread between fair market value and your strike price—even though you haven’t sold anything.

But here’s the key insight for acquisitions: if your options are cashed out at close (exercise and sale happen simultaneously), AMT usually becomes irrelevant. The issue shifts to ordinary income treatment instead. AMT primarily matters when you exercise and then hold shares—which is rarely an option in a cash acquisition.

Vesting Acceleration: Not What Most People Think

“Vesting acceleration” sounds like a windfall. Your unvested equity suddenly vests! But the reality is more nuanced.

Single-trigger acceleration: Equity vests automatically at the acquisition close. This is becoming less common because acquirers don’t love it—it removes retention leverage.

Double-trigger acceleration: Equity only accelerates if you’re terminated (or resign for “good reason”) within a defined period after close. This is far more common. It means your unvested equity doesn’t vest at the acquisition—it vests only if you lose your job later.

Why this matters: double-trigger acceleration means no immediate tax event from your unvested equity. The vesting continues normally, or accelerates later if you’re let go. This is often more tax-efficient than single-trigger, which can create a massive income spike in one tax year.

Retention RSUs: New Equity, New Rules

If you’re a key employee, the acquirer may offer you a retention package—often RSUs in their stock. This is completely separate from your existing startup equity and has its own tax treatment.

RSUs are taxed as ordinary income when they vest. There’s no QSBS. No capital gains treatment on the initial value. If you receive $500,000 in RSUs that vest over four years, you’ll recognize roughly $125,000 of W-2 income each year (at the vesting date stock price).

The planning opportunities with RSUs are about timing and structure:

Vesting schedule. Can you negotiate the schedule to avoid stacking huge income in the same year as your acquisition payout?

Withholding. Default supplemental withholding is often insufficient for high earners. You may need to plan for estimated tax payments.

State sourcing. If you’re planning to move, understand that states like California source RSU income based on where you worked during the vesting period, not just where you live when it vests.

The Decisions That Actually Matter

Here’s the uncomfortable truth: by the time an acquisition is announced, most of your tax outcomes are already determined by decisions you made (or didn’t make) years ago. Whether you early-exercised. When you exercised. Whether you held.

But there are still things you can influence:

Understanding what you have. Build a lot-by-lot picture of your equity: exercise dates, basis, potential QSBS status, holding period. You cannot make good decisions without this.

Knowing the deal mechanics. Cash or stock? Rollover options? Treatment of vested versus unvested? These answers drive everything else.

Timing awareness. If any lot is close to the 5-year QSBS mark, timing can matter enormously. In rare cases, closing date can be negotiated (though this is usually not within an individual employee’s control).

Tax projection. Understanding how your acquisition payout, RSU vesting, and regular compensation stack in the close year helps you plan for estimated taxes and avoid surprises.

Withholding and estimated taxes. Large acquisitions create large tax bills. Default withholding is often inadequate. Plan for this or face penalties and a painful April.

Where People Get Burned

Assuming QSBS applies. It’s not automatic. Many people never exercised early enough, or exercised after the company crossed $50M in assets. You need to verify, not assume.

Forgetting about California. Federal QSBS is wonderful. California taxation on the same gain is not wonderful. Plan for both.

Mixing up shares and options. Shares you own have different treatment than options you hold. The acquisition forces different outcomes for each. Know which is which.

Missing the holding period by weeks. QSBS requires more than 5 years. If you exercised on March 15, 2020, you need to hold until at least March 16, 2025. Days matter.

Poor documentation. QSBS eligibility is self-reported. If audited, you need to support your position. Keep exercise records, company representations, and your analysis organized.

Waiting too long to plan. Many tax decisions are irreversible. By the time you’re asking questions at the closing dinner, it’s too late.

How QSBS Eligibility Is Actually Verified

There’s no IRS pre-approval for QSBS. No stamp of certification. You claim the exclusion on your tax return and must be able to support it if questioned.

In practice, QSBS eligibility relies on two types of verification:

Shareholder-level facts you can confirm yourself: exercise dates, acquisition method (original issuance vs. secondary), holding period, ownership structure.

Company-level facts that require verification from the company: C-corp status, gross assets at issuance, qualified business test, redemption history. For these, you typically obtain written representations from company counsel or the CFO. Some companies proactively provide QSBS attestation letters; others require you to request this information.

Keep everything organized. If the IRS ever questions your exclusion, you’ll need to show your work.

The Bottom Line

An acquisition is exciting. It’s also the moment when years of equity accumulation becomes concrete—and when the tax code becomes very real. The decisions you make in the weeks before closing can mean the difference between keeping the majority of your payout and giving a surprising chunk to the government.

The framework is straightforward:

1. Separate your equity into buckets (exercised shares, unexercised options, future RSUs)

2. Understand how the acquisition treats each bucket

3. Determine QSBS eligibility lot by lot

4. Know which decisions are fixed versus flexible

5. Plan for the tax bill, including state taxes

This isn’t about aggressive tax avoidance. It’s about understanding what you’re entitled to under the law and not leaving money on the table due to confusion or poor timing.

If your equity situation is complex—multiple exercise dates, QSBS potential, California residency, pending acquisition timing—work with an advisor who understands these issues before the deal closes. The cost of good advice is almost always less than the cost of getting it wrong.

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