What’s the Difference Between a Compensatory vs Non-Compensatory Tender Offer?

Summary: In a tender offer, your company is providing you the opportunity to sell a portion of your vested shares at a fixed price (if you qualify, and typically subject to limits on how much you can sell). But there's a major tax distinction that can catch employees off guard: whether the tender is considered compensatory or non-compensatory. This classification can dramatically affect how your gains are taxed—even if you've met the ISO holding period requirements.

Details: In a tender offer, the company decides:

• Who can sell

• How much can be sold

• The share price

• Whether the transaction is "compensatory" (this is the critical one)

If the deal is compensatory, then a portion of the sale will be treated and taxed like compensation. Specifically, the sale price above the 409A valuation (fair market value) is taxed as ordinary income.

If the deal is non-compensatory, then it will work as most expect/like a traditional sale, with all of the gains qualifying as capital gains

This effects both NSOs and ISOs, and can have a large impact on which shares (or vested options) you select to sell to tax-optimize.

Example:

RocketCo is holding a tender offer for $20 a share. Their 409A Valuation is $5/share. One of the company's first employees has 100,000 ISOs (issued 4 years ago) with a strike price of $0.05. The grant is fully vested, and they also purchased all 100,000 of the shares three years ago.

• If tender is compensatory:

  • First $4.95 = long-term capital gain (difference between $0.05 and $5 FMV)

  • $15 = taxed as ordinary income (difference between $5 FMV and $20 tender price)

• If tender is non-compensatory:

  • Entire $19.95 gain ($20 - $0.05) = taxed as long-term capital gain (assuming ISO holding periods were met)