Julia T. Kovacs, Partner, DLA Piper Washington, DC

Transcription

1 Equity Compensation Issues in M&A Julia T. Kovacs, Partner, DLA Piper Washington, DC *This presentation is offered for informational purposes only, and the content should not be construed as legal advice on any matter.

2 Introduction What we will cover: Due diligence issues Treatment of equity comp awards in transaction Section 280G 2

3 Due diligence issues Stock options shareholder approval If ISOs are outstanding, did shareholders approve the equity incentive plan s set share reserve and any share increases within 12 months of adoption? Concern: If shareholder approval was not obtained timely, the options were nonquals subject to withholding on exercise (ISOs are exempt from withholding). 3

4 Due diligence issues Stock options exercise price Is the exercise price no less than FMV on the date of grant? Obtain valuations and valuation method. Concern: If regular options are granted with an exercise price below FMV on the date of grant (discount options), they violate Section 409A, resulting in tax penalties. 4

5 Due diligence issues Stock options documentation Were all grants papered within a reasonable time after grant? Concern: If grants are not papered within a reasonable time after grant, the grant date and therefore non-discount exercise price is not established, which may result in an option that violates Section 409A. 5

6 Due diligence issues Restricted stock Did holders make an 83(b) election within 30 days after grant? Concern: If they did, there is no ordinary income upon vesting on a change in control. If they did not, there is ordinary income upon vesting on a change in control. 6

7 Due diligence issues Restricted stock units Are RSUs subject to Section 409A or exempt? Concern: Special rules apply to RSUs that are subject to Section 409A. 7

8 Depends in part on the terms of the equity incentive plan and award agreements: Does the transaction meet the definition of change in control in the plan document? Does the plan require a particular treatment of awards? Does the plan permit a choice between permissible methods? Will vesting automatically accelerate? If the proposed treatment in the deal is not consistent with the terms of the plan and agreements, is holder consent required? 8

9 Stock options in a stock transaction: Cashout and/or Rollover 9

10 Stock option cashout: Pro: No post-closing administration of old awards Incentive to work towards closing Con: Lose retention value of outstanding award Need to grant new awards as incentive 10

11 Stock option cashout: Ordinary income equal to spread May be paid on a deferred basis with earn-out/escrow up to 5 years Subject to income and employment tax withholding on payment Target gets the deduction (IRS AM ) Typically paid through target payroll; try to get release of claims Consideration and consent may be required to cancel underwater options; Lillis v. AT&T Corp. 11

12 Cashout vs. exercise before closing? If ISOs are exercised soon before closing and shares are sold, spread at exercise is ordinary income, but there is no tax withholding and no employment tax Consider tax savings versus administrative issues of adding to shareholder base before closing Consider potential difficulty determining the FMV of the shares at exercise before closing to determine taxable spread if deal consideration will be deferred, subject to earnout, or escrow 12

13 Restricted stock cashout: If an 83(b) election was made at grant, no ordinary income at sale; capital gain or loss on the difference between per share acquisition price and FMV at grant If an 83(b) election was not made at grant, ordinary income upon CIC vesting, subject to withholding, on the excess of the per share acquisition price over the amount the holder paid for the award (if any) 13

14 Restricted stock units cashout: If RSUs are exempt from Section 409A, may accelerate and payout RSUs at closing If RSUs are subject to Section 409A, may use special Section 409A rule to terminate all RSUs of all holders affected by the transaction and all similar arrangements and payout at closing Ordinary income, subject to withholding, equal to the cash or value of shares received at payout 14

15 Stock option rollover: To maintain ISO status, ISO rules require adjustment of the option so that the post-transaction assumed/substituted option does not provide the holder with additional benefits Adjust exercise price and number of shares Do not modify underlying option terms Section 409A rules applicable to nonquals are similar 15

16 Stock option rollover: How to adjust exercise price and number of shares: Spread test Spread value of new option must be the same as the old option Ratio test On a share-by-share basis, the ratio of the exercise price to FMV of each new option may not be less than the ratio of the exercise price to FMV of each old option 16

17 Stock option rollover: How to adjust exercise price and number of shares: Example A to buy T shares for $40/share and assume options. Value of A shares post-closing is $20/share. Employee has an ISO to purchase 100 T shares at $10/share exercise price. Spread value of old option: 100 * ($40 - $10) = $3,000 Ratio of exercise price to FMV of old stock option is: $10/$40 How to convert: Conversion ratio = T share value / A share value = $40/$20 = 2.0 To get shares for new option: 100 (T option shares) x 2.0 = 200 (A option shares) To get exercise price for new option: $10 (T exercise price) / 2.0 = $5 (A exercise price) Spread value of new option: 200 * ($20 - $5) = $3,000 Ratio of exercise price to FMV of new stock option is: $5/$20 17

18 RSU rollover: If RSU is subject to Section 409A, payout on original schedule Or, if RSU would accelerate and be paid out on the change in control, a special Section 409A rule would allow the parties to avoid acceleration and add new vesting criteria for the award to remain outstanding and vest at a later date 18

19 Tax consequences of rollover of awards: If options are assumed/substituted in accordance with the rules described above, the assumption is not taxable and ISOs retain status as ISOs RSU assumption is not taxable Restricted stock assumption taxable under normal property disposition rules 19

20 Equity comp in an asset transaction: Optionee has a termination of employment; unvested options terminate, vested options may be exercisable for a short period post-termination Review RSU to determine whether CIC triggers payout or Section 409A may permit continuation 20

21 Section 280G Section 280G golden parachute provisions: Apply to C corporations Do not apply to S corps (or a company that could be an S corp) Do not apply to LLCs (however, be careful if part of a larger controlled group) 21

22 Section 280G You have an issue if: Compensatory payments or benefits payable to certain executives equals or exceeds 3 times their base amount Base amount is executive s average Box 1 W-2 or 1099 comp from the company for the past 5 years (or shorter period of service) Compensatory payments include: value of equity vesting, full value of grants within 1 year before the CIC, grants promised by acquiror, severance, CIC bonuses, etc. Then: Excess of contingent payments over 1 times the base amount is nondeductible to the company and subject to a 20% excise tax payable by the executive 22

23 Section 280G 280G cleanse Private company can avoid all 280G issues by disclosing all contingent payments to shareholders and obtaining more than 75% shareholder approval However, before the approval is sought, the executive must waive any and all rights to the excess amounts so that his right to the benefits is wholly subject to shareholder approval All shareholders must receive full disclosure of the payments even if their vote is not needed to get the more than 75% approval 23

24 Section 280G Typical issues/surprises: The one year presumption Including the value of post-cic arrangements: agreed precic? Reasonable compensation for future services? I have > 75% vote with my private equity holders we really have to disclose all this comp to the other shareholders? Yes Pass-through voting to entity holders shareholders if target company assets are 1/3 or more of holder s assets and holder is >1% shareholder 83(b) election disregarded when determining amount of parachute payment (but included in base amount) 24

25 Julia T. Kovacs DLA Piper 500 8th St NW Washington, DC Office Phone: Circular 230 Notice: In compliance with U.S. Treasury Regulations, please be advised that any tax advice given herein (or in any attachment) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax penalties or (ii) promoting, marketing or recommending to another person any transaction or matter addressed herein. 25