Drafting and Designing Equity Incentive Plans (with Form) Roger C. Siske

Transcription

1 Drafting and Designing Equity Incentive Plans (with Form) Roger C. Siske Roger C. Siske is a partner in the Chicago office of Sonnenshein Nath & Rosenthal. He is former chair of the Joint Committee on Employee Benefits of the ABA s Section of Business Law. A complete set of the course materials from which this outline was drawn may be purchased from ALI-ABA. Call CLE-NEWS. Have the number of the course materials SF90 handy. IPO, refers to initial placement offering; IRC, to the Internal Revenue Code; SAR, to stock appreciation right; and LSAR, to limited stock appreciation right. A. Introduction 1. The advantages of equity incentive plans are many. But, assuming you and your client have already decided to implement an equity incentive plan, how do you design and draft it? 2. Numerous questions need to be answered and numerous issues considered both practical and legal. B. Scope of Plan 1. How many shares will be available under the equity incentive plan? a. The quantity of shares may be limited by the type of grant (e.g., restricted stock, stock appreciation rights). b. The quantity of shares may be subject to individual limits (annual, in aggregate, and by the type of grant). c. How will limits be counted? i. Will prior grants lapse? Will ungranted shares under a prior plan be counted? 2. What will the duration of the plan be? 3. Who will be covered under the plan? a. Employees: i. Employees of the parent company? i Employees of the subsidiary? Domestic employees? Foreign employees? b. Non-Employees: i. Outside directors? Employees of non-subsidiary affiliates (e.g., 40 percent joint venture

2 employees)? i C. Types of Grant 1. Options: Leased employees? Independent contractors, including consultants? a. What types of options will be granted? i. Non-qualified options? Incentive stock options? b. What will the term (maximum option term) be? i. 10 years? i 20 years? Other? c. What will the price be? i. At market? i Below market generally or solely to convert options of acquired companies? Premium options? d. Upon what will exercisability of the options depend? i. Will exercisablity depend on vesting? Will it depend on service? If so, what will constitute performance? i Will there be specified termination events (termination without cause, termination for good reason, death, disability, normal retirement, after change of control, other? What will happen to option exercise rights after the employee is terminated? e. How will the exercise price be paid? i. Cash? i Share withholding? Stock swap? Broker dealer payment? v. Note or loan? f. How will payment of withholding taxes upon exercise be accomplished? i. Cash? i Share withholding? Stock swap?

3 Broker deal payment? v. Note or loan? g. Will there be reload options upon exercise? h. Option purchases options in lieu of compensation (i.e. salary, bonus, or other benefits) i. How will the issuance of shares be timed? i. Upon option exercise? Deferred transfer and issuance? 2. Will there be restricted stock? 3. Will there be deferred stock? 4. Will there be SARs? LSARs? 5. Will there be performance units and performance shares? 6. Will there be bonus shares? D. Administration 1. Will the administration of the equity incentive plan be vested in an independent board committee? 2. May the independent board committee delegate that authority with respect to: a. Non-16b grantees? b. Non-162(m) grantees? c. Foreign subsidiary-subplans? 3. How will the administrative authority be defined and limited? a. Will the administrative authority be discretionary or interpretative? b. Will the administrative authority include powers to amend or terminate outstanding grants? c. Will the administrative authority include powers to approve or disapprove special provisions such as: i. Accelerated vesting? i Extended termination of exercise period? Change of control vesting? Tax withholding required minimum tax withholding or the full tax cost? d. Categories of determinations i. Forfeitures and clawbacks of benefits (e.g., termination for cause, violation of restrictive covenants and other reasons); General determinations.

4 E. Transferability of Grants 1. Will there be broad non-transferability except upon death? 2. Will family and trusts be excepted from a non-transferability restriction? 3. Will charities be excepted from non-transferability? F. Change of Control Considerations 1. How will a change of corporate control affect rights under the equity incentive plan? What safeguards should be included in the plan to hinder a change in control? 2. To deal with these concerns, should you include provisions dealing with: a. Accelerated vesting? b. Extended ability to exercise? c. Acceleration of performance standards? d. Pooling of interests? e. Conversion into buyer securities (at employer or employee election)? f. Definition of change of control? G. Key Considerations in Plan Design 1. Business and human resource objectives will, in large measure, dictate the plan design. 2. Corporate law requirements and restrictions will also dictate elements of the plan design. a. Board judgments will be controlled by: i. The business judgment rule; i The entire fairness test; and The Unocal (493 A.2d 946) standard. b. Requirements for share issuance and redemptions may be imposed by corporate law; c. Options and other grant validity may be determined by corporate law; d. Corporate law may determine shareholder approval requirements. 3. Consider security law issues: a. Federal and state registration and exemption; b. Section 16 issues: i. Section 16a reporting; and Section 16b liability and exemptions. 4. Consider the effect of financial accounting rules: a. Compensation-expense accounting issues;

5 b. Pooling of interest issues. 5. Consider the federal, state, and foreign tax treatment of: a. The grantees; b. The company. 6. Consider institutional and venture capital shareholder issues: a. Shareholder dilution and share overhang; b. Proxy voting issues; c. Red flag issues: i. Option repricing; i Discounted options; Cheap stock; and Plan grants without shareholder approval. 7. Consider listing requirements. H. Grantee Liquidity Issues 1. Tag-along rights; 2. Piggy back registration rights (post-ipo); 3. Demand registration right (post-ipo); 4. Drag-along rights. I. Grantor Control Issues 1. Shareholder agreements and other restrictions: a. Transferability of shares; b. Rights of first refusal; c. Repurchase rights. 2. Shareholder approval. J. Reserved Rights To Amend and Termination Plan 1. Generally; 2. In the event of a transaction (e.g., merger, sale of assets, going private). Appendix ABC Corporation Equity Incentive Plan ARTICLE 1. ESTABLISHMENT, OBJECTIVES, AND DURATION 1.1 Establishment of the Plan. ABC Corporation, a Delaware corporation (the Company ), hereby establishes an incentive compensation plan to be known as the