www.pwc.com 1 st Annual Southwest Roundup Equity Issues & Corporate Restructurings June 7, 2013
Summary of Discussion Items Types of Corporate Transactions - How will awards be adjusted? Tax and Accounting Implications - Stock Options - Restricted shares - Performance awards Global Ramifications - Regulatory Consideration - Terms/Documentation Other Issues for Consideration Questions? 1 st Annual Southwest Roundup June 2013 2
Types of Corporate Transactions Acquisitions - One company takes over another - Target company ceases to exist - Buyer remains and stock continues to trade - Generally, unfriendly deals are acquisitions Merger - Two similar size organizations agree to go operate as a single new company - Both companies' stocks are surrendered and new company stock is issued in its place - Real life few true mergers of equals Spin-Off - Company separates a division, subsidiary, or part of its business from the parent company - New independent company is formed 3
Mechanics of Corporate Transactions Acquisitions Target options may be: - Converted to options over Buyer stock - Cancelled - Accelerated - Cashed-out; or - Stock out (i.e., options exchanged for acquiring company stock with value equal to the aggregate option spread at the time of the transaction) Some plans permit individual option holders to be treated differently for example, cashing out vested options and assuming all the unvested options 4
Mechanics of Corporate Transactions Acquisitions Restricted stock - Generally treated in same manner as all other stock of the target company as individuals are deemed shareholders - Stock out (i.e., options exchanged for acquiring company stock with value equal to the aggregate option spread at the time of the transaction) Restricted stock units/ SARs - Target s equity plan should define consequences of transaction on its RSUs and SARs - May require assumptions of the award; cancellation of award or acceleration of vesting - Consider 409A implications 5
Mechanics of Corporate Transactions Spin-Off SpinCo employees Convert Parent options to SpinCo options Combination of SpinCo and Parent options Choice between Parent or SpinCo options (rarely offered) Parent employees Repriced and resized Parent options SpinCo options (rarely offered) Combination of Parent and SpinCo options Choice between Parent and SpinCo options (rarely offered) 6
Mechanics of Corporate Transactions Spin-Off Options held by Company X employees who remain Company X employees will be adjusted (strike price and number) to preserve existing intrinsic value, vesting, and term Unvested Options held by Company X employees who become Company Y employees will be converted to Company Y options. Exercise price and number of Company Y options will be adjusted to preserve intrinsic value. - Vested options may either be converted or will stay in parent stock Going forward, Company X employees get Company X options/ Company Y employees get Company Y options. 7
Mechanics of Corporate Transactions Spin-Off Day Before the Spin-off Parent Company Share Price $10 Number of Option Shares 1,000 Exercise Price of Stock Option $5 Total Value of Stock Option $5,000 Employee of Parent Company on the Day of the Spin-off Parent Company Share Price $8 Number of Option Shares 1,250 Exercise Price of Stock Option $4 Total Value of Stock Option $5,000 Adjustment ratio = 0.8 Adjustment to number of options = 1,000 / 0.8 = 1,250 Adjustment of exercise price = $5 x adjustment ratio = $4 **Total Value of Stock Option equals the difference between the fair market value of the underlying share and the exercise price multiplied by the number of options 8
Best Practices Review documentation - All equity plans and related agreements should be reviewed in light of the transaction - These documents should provide guidance as to the mechanical implications of the transaction - Do not forget the special award agreements, or severance/retention agreements which might supersede the standard plan document 1 st Annual Southwest Roundup June 2013 9
Tax & Accounting Implications Stock Options Non-Qualified Stock Options NQSOs can be assumed in an acquisition without tax acceleration - Economics should be maintained (i.e., comply with spread test under Code Section 424) - If not, may be viewed as a new grant to be tested under Reg. 1.83-7 10
Tax & Accounting Implications Stock Options Incentive Stock Options Incentive Stock Options (ISOs) can be also be assumed without tax acceleration - Must maintain pure neutrality in economics and terms ( spread and ratio test in Reg. 1.425-1) Spread test: The pre-substitution aggregate option spread cannot exceed the post-substitution aggregate option spread Ratio test: The ratio of the option price to the FMV of the shares subject to option immediately after the change in the option/issuance of new options cannot be more favorable to option holder than before the change - If not, ISO is deemed modified and becomes non-qualified stock option 11
Tax & Accounting Implications Stock Options Incentive Stock Options Unlike when other changes are made, vesting acceleration itself will not cause modification of ISO - However, $100,000 per year vesting limit may be violated by options whose vesting has been pushed-up - Also, options that have vested and were exercised earlier in the year as ISOs might now be viewed as NQSOs if options granted earlier than the ones exercised are accelerated - Company also needs to consider any withholding issues that may arise Further, the acceleration of vesting of an ISO does not trigger an immediate taxable event 12
Tax & Accounting Implications Restricted Stock An exchange of target company restricted stock for restricted consideration (either restricted stock or restricted cash) may be taxable if the transaction itself is generally taxable for the shareholders - For example, if the transaction does not qualify as a tax-free reorganization In a tax free reorganization, restricted property that is assumed by the purchaser maintains tax-deferred status as long as substantial risk of forfeiture remains 13
Tax & Accounting Implications Performance Vesting Many equity awards now contain performance conditions; what happens in a corporate transaction? - Will the awards be cancelled if the performance goals are not achieved at the time of the transaction? - Will the company decide to waive the performance conditions? - Will the Board have discretion to waive some or all of the performance conditions? 14
Tax & Accounting Implications Performance Vesting - Accounting Implications: Consideration of what happens from a US GAAP perspective if performance conditions are waived - Section 162(m) Waiver of performance conditions will subject the awards to the deduction limitations under Section 162m although only relevant of the employees of the target company become part of the top four officers of the acquiring company - Section 280G Waiver of the performance conditions that vests solely due to performance conditions will cause the award to be treated as a parachute payment under Section 280G 15
Tax & Accounting Implications - General US GAAP Considerations Incremental Expense - Generally continue to account for original award plus any incremental cost of the new grant - Incremental expense = the excess of the new award fair value over the fair value of the original award at modification date Incremental value expensed immediately for vested options Incremental value added to unrecognized original value of unvested options and expensed over remaining vesting period - If the new award fair value is less than the current fair value of the original award, no incremental expense is recorded - The original expense associated with the original award cannot be reduced by the incremental expense 16
Global Considerations Options granted to employees outside the US generally structured to minimize tax burden to employees under local law (e.g., UK approved share scheme, French qualified option plan) Conversion of options, for any option holder may trigger unfavorable tax consequences in many countries Holding period will generally restart or tax conversion options as a new grant Difficult to structure conversion to get tax neutral treatment in a foreign country and maintaining no expense for accounting purpose Cash-out of equity awards may be taxed less favorably than assumption/substitution of awards 17
Global Considerations Need to assess on country-by-country basis: Current qualified plan and tax situations Tax withholding and reporting obligations for cross-employer awards Alternatives available under local tax laws Tax, Securities and Legal filing requirements Communications to colleagues Chargeback opportunities under new structure Administration issues conversion and ongoing 18
Global Considerations - Regulatory Conversion of Outstanding Awards Is the conversion an offering of securities? (e.g., Australia and the EU) Do any regulatory filings that have already been made need to be amended? (e.g., China SAFE filing, Philippines securities filing) Do you need consent from employees to convert? 19
Global Considerations Terms/Documentation Important to clearly communicate to employees how the conversion will work and how it may affect the taxation of their awards Check to make sure that award agreements have been signed and may want employees to execute a new award agreement Make sure that new terms are clearly documented and understood (is this really a substitution or an assumption of existing terms?) 20
Other Issues Benefits Inventory existing plans Any shared benefit platform should be evaluated, cloned, replaced or abandoned; any stand alone program re-valuated Domestic health, retirement, vacation, sick, adoption, scholarship, credit union, insurance, FSA, etc. Country specific retirement and pooled arrangements Country specific fringe (car, food, clothing allowances, etc.) Catalog of benefits per company per country Split of any liability and assets and creation of recipient programs Benchmark for industry and size and trends Establish compliance baseline Vendor contract review Draft process and procedures 21
Other Issues Section 162(m) Deductions limited to $1 million for compensation paid to top four executives of publicly held companies (excluding CFO) Reg. 1.162-27(c)(1) states that a publicly traded company is one who, on the last day of its taxable year is subject to the reporting obligations of 12 of the SEC exchange Act So, if a company is acquired, it generally does not have to file a proxy for the short period ending on the acquisition date and thus Section 162(m) is inapplicable 22
Contact Information AmyLynn Flood Partner - GHRS 267-330-6274 amy.lynn.flood@us.pwc.com Terry Richardson Partner - GHRS 214-999-2549 terrance.f.richardson@us.pwc.com 23
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