Meaning
Legal instrument used by option holders to convert their rights into shares only upon the occurrence of a specific transaction allows for simultaneous closing and settlement. A conditional exercise notice typically specifies that the exercise only takes effect if an exit event or a change of control completes by a certain date. This prevents the holder from becoming a shareholder if the deal fails.
It is a tool in mergers and acquisitions where employees wish to participate in the sale without spending cash upfront.
Contingency Provision
Transaction success is the primary requirement for the validity of the conversion. If the underlying sale does not occur, the conditional exercise notice becomes void and the individual remains an option holder. This ensures that the cap table remains unchanged unless a liquidity event is certain.
Tax Timing
Deferred conversion allows the holder to avoid paying tax on the gain until the moment they receive cash from the sale. Because the conditional exercise notice triggers the issuance of shares exactly when the company is sold, the exercise price and the sale price are realized together. This eliminates the risk of holding illiquid shares while facing a tax bill.
The holder effectively converts and sells in a single motion.
Option Finality
Documents signed in advance of the closing provide the company with the authority to process the entire option pool at once. Once the sale completes, the conditional exercise notice cannot be revoked by the employee. Notices provide certainty for both the issuer and the holder.
