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Employee equity incentives
- 1. Employee Equity Incentives
Presented by Bart Greenberg
Haynes and Boone, LLP
Tech Coast Venture Network
Monthly Workshop Series
May 5, 2011
© 2010 Haynes and Boone, LLP
- 3. Business Purpose for the Plan
Recruit and retain scarce talent
Motivate employees to perform
Align employee interests with owners
Create a compensation “fill-gap”
Facilitate succession planning
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 4. Ownership and Management
What is the current ownership structure of the
Company?
Are these owners willing to dilute their
ownership position?
Is voting control an issue?
How will the extension of equity be viewed by
the existing management?
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 5. Legal Form of the Company
Sole Proprietorship
Partnership
General
Limited
Corporation
S Corporation
C Corporation
Limited Liability Company
Limited Liability Partnership
Professional Businesses
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 6. Capital Needs of the Company
Does the Company need capital?
Will the Company be seeking outside
investors?
How would prospective investors view the
plan?
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 7. Company’s Financial Situation
What is the financial condition of the Company?
Is the Company generating profits?
What is the cash position of the Company?
Will it be cost effective for the Company to
implement and administer the plan?
What are the costs to the Company?
What are the costs to the employee?
How will the proposed plan affect the Company’s
financial statements?
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 8. Future Growth Plans
What is the growth projection for the
Company?
Start-up with great growth potential
Mature company with slower growth
How will liquidity of the investment be
obtained?
Cash award or redemption
Liquidity event of Company
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 9. Company Culture
What is the Company’s culture?
Individual-based compensation approach;
or
Broad-based compensation approach
How will the plan be perceived by employees?
Is it designed to reinforce the Company
culture?
Will it be perceived by employees as being
fair?
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 10. Industry Norms
Employee desires, expectations and needs
What is the competitive landscape?
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 11. Tax Considerations
What are the available tax incentives for the
Company?
Deductibility of the award
Obligation to withhold
What are the available tax incentives for the
Employee?
Will there be recognition of income?
Capacity to pay withholding obligations
Compensation income vs. capital gains
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 12. Tax Considerations (cont.)
Pitfalls to avoid
Deferred compensation taxation (Section 409A)
Parachute payment taxation (Section 280G)
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 13. Specific Plan Design Issues
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 14. Types of Plans
Direct Stock Purchases
Stock Options
Phantom Stock and Share Appreciation Rights
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 16. Eligibility and Participation
Typically, individual-based approach
Potentially, broad-based approach via stock
purchase plan
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 17. Size of Grant
Typically, case by case
Could be limited by securities requirements
Section 25102(o) limits pools to 30% of outstanding
shares unless approved by 2/3 of outstanding shares
Rule 701 limits aggregate sales price or amount of
securities being sold in reliance on Rule 701 during
any 12 month period to:
$1 million (aggregate exercise price on date of
grant);
15% of total assets; or
15% of outstanding securities
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 18. Size of Grant (cont.)
Could be limited by other concerns
Carve-outs to application of anti-dilution
provisions
Exceptions to preemptive and other similar
rights
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 19. Type of Grant
Unrestricted
Not subject to forfeiture
Restricted
Subject to forfeiture
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 20. Tax Treatment
Unrestricted
Ordinary income to the extent FMV exceeds
purchase price
The Company has a reciprocal compensation
deduction
Any profit at sale will be afforded capital
gains treatment
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 21. Tax Treatment (cont.)
Restricted
Recognition of ordinary income as and
when restrictions lapse
If, however, Section 83(b) election is made,
see “Unrestricted”
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 22. Payment of Purchase Price
All cash
All note
If permitted pursuant to a stock purchase
plan; or
If adequately secured by collateral other than
shares
Sarbanes-Oxley prohibition on loans to top-
level officers should be considered
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 23. Payment of Purchase Price (cont.)
Combination of any of the above
Other types of legal consideration
Labor or Services Actually Rendered
Debts or Securities Cancelled
Tangible or Intangible Property
Section 83(b) election may be challenged if
significant portion of payment (typically 80%
or more) consists of a nonrecourse note
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 24. Vesting
Passage of Time
Performance Based
Individual Performance
Company Performance
Combination of Time and Performance Vesting
Acceleration of Vesting
Determination of Triggers
Accounting Considerations
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 25. Purchase Price
Subject to securities requirements and tax issues,
no restrictions
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 26. Voting Rights
Full voting rights at time of purchase
Consider protective provisions
Tag-a-long rights
Drag-a-long rights
Potential limitations on voting rights
Use of non-voting stock
Grant of revocable or irrevocable proxy
Use of shareholders’ or voting agreement
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 27. Securities Requirements & Filings
If individual-based approach, could be subject to
investor suitability requirements
If broad-based approach and subject to Section
25102(o), plan could must provide for delivery by
Company of annual financial statements
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 28. Securities Requirements & Filings (cont.)
Rule 701 requires additional disclosure (plan
summary, risk factors and financials) if sales
exceed $5 million during any 12 consecutive
months
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 30. Eligibility and Participation
A broad-based approach through use of plan
Potentially, individual-based approach through:
Limited grants of options under plan
Grant of options outside of any plan
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 31. Size of Option Pool
Typically, case by case
Could be limited by securities requirements
Section 25102(o) limits pools to 30% of outstanding
shares unless approved by 2/3 of outstanding
shares
Rule 701 limits aggregate sales price or amount of
securities being sold in reliance on Rule 701 during
any 12 month period to:
$1 million (aggregate exercise price on date of
grant);
15% of total assets; or
15% of outstanding securities
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 32. Size of Option Pool (cont.)
Could be limited by other concerns
Carve-outs to application of anti-dilution
provisions
Exceptions to preemptive and other similar
rights
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 33. Size of Option Grant
Typically, left to the discretion of the board
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 34. Type of Options
Incentive stock options
Grantee must be an employee
Exercise price must be > FMV
Other statutory requirements
Nonqualified stock options
Any option other than an incentive stock
option
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 35. Tax Treatment
Incentive stock options
No tax deduction for the Company at grant or
exercise
Capital gains treatment to optionee upon sale
of stock
Potential AMT liability to optionee at time of
exercise
In the event of a disqualifying event, see
Nonqualified stock options
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 36. Tax Treatment (cont.)
Nonqualified stock options
Tax deduction at exercise in amount equal
to “spread”
Ordinary income to optionee in amount of
spread at exercise
Potential ordinary income at grant if
negligible exercise price
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 37. Tax Treatment (cont.)
[Potentially] subject to deferred compensation
taxation (accelerated taxation, interest charge
and 20% excise tax) if exercise price < FMV
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 38. Exercise Price
Incentive stock option
Must be FMV at time of grant (110% if 10%
shareholder)
Nonqualified stock option
For tax purposes, no restriction (however, may
be subject to deferred compensation taxation
under Section 409A if < FMV)
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 39. Vesting
Passage of Time
Performance Based
Individual Performance
Company Performance
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 40. Vesting (cont.)
Combination of Time and Performance Vesting
Acceleration of Vesting
Definition of Triggers
Accounting Considerations
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 41. Term and Termination
Incentive stock options
No option may be granted after 10th
anniversary of Plan
Limitations on periods after termination of
employment by which option must be
exercised
Nonqualified stock options
Section 25102(o) provides that no option may
be granted after 10th anniversary of Plan
Section 25102(o) limits periods of time by
which option must be exercised
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 42. Payment of Shares
All cash
All note
If permitted pursuant to a stock option
plan; or
If adequately secured by collateral other
than shares
Sarbanes-Oxley prohibition on loans to top-
level officers should be considered
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 43. Payment of Shares (cont.)
Other types of legal consideration
Labor or Services Actually Rendered
Debts or Securities Cancelled
Surrender of Option Shares
Tangible or Intangible Property
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 44. Voting Rights
Full voting rights at time of purchase
Consider protective provisions
Tag-a-long rights
Drag-a-long rights
Potential limitations on voting rights
Use of non-voting stock
Grant of revocable or irrevocable proxy
Use of shareholders’ or voting agreement
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 45. Securities Requirements & Filings
If individual-based approach, could be subject to
investor suitability requirements
If broad-based approach and subject to Section 25102(o),
plan must provide for delivery by Company of annual
financial statements
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 46. Securities Requirements & Filings (cont.)
Rule 701 requires additional disclosure (plan
summary, risk factors and financials) if sales
exceed $5 million during any 12 consecutive
months
The number of option holders should be closely
watched so that the company does not trigger
reporting requirements when the exercises occur.
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 47. Phantom Stock and
Share Appreciation Rights
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 48. Eligibility and Participation
Typically, individual-based approach
Potentially, broad-based approach through plan
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 49. Size of Grant
No restrictions
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 50. Tax Treatment
Company has tax deduction on date of
payment in amount equal to appreciation
Ordinary income to employee at time of
payment
Deferred compensation taxation (accelerated
taxation, interest charge and 20% excise tax)
may apply
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 51. Accounting Treatment
Benefits must be entered as an expense and
book liability for accounting purposes when
and as accrued
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 52. “Exercise Price”
No restrictions
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 53. “Payment for Shares”
No actual payment is made
Employee receives cash award equal to
difference between unit value and FMV
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 54. Voting Rights
None
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 55. Securities Requirements & Filings
In general, as no equity is involved, securities
laws are not applicable
However, there is a new trend to settle with
shares, not cash, which raises security law
issues
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP
- 57. Thank you!
Bart Greenberg
Haynes and Boone, LLP
(949) 202-3037
bart.greenberg@haynesboone.com
June 3, 2010 Employee Equity Incentives
© 2010 Haynes and Boone, LLP