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Forms of executive compensation; executive compensation for privately held companies

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  1. 1. Presented byForms of Executive CompensationDaniel N. JanichGreensfelder, Hemker & Gale, P.C.200 West Madison Street, Suite 2700Chicago, IL 60606312-345-5003 | dnj@greensfelder.com2013 NCEO/Beyster Institute EmployeeOwnership ConferenceSeattle, WashingtonApril 23, 2013
  2. 2. Executive Compensationfor Privately-Held Companies• Has increasingly grown more complex indesign and administration• Sarbanes-Oxley• §409A• Federal & State Securities Laws• §409(p)• ESOP trustee responsibilities• Heightened challenges to attracting,retaining and motivating C-levelexecutives in the age of social media
  3. 3. • Experienced ESOP Legal Counsel• Accountant & Tax Advisor• Executive CompensationConsultant/Surveys• Valuation Expert• Independent TrusteeWho Are Your Professional Advisors?
  4. 4. • Every company has one• Influenced by company culture• Market-Based – Use of Compensation Surveysand/or Compensation Consultants• Internal Equity• How Much Compensation Should Be Fixed vs.at Risk?• Who is Final Arbiter? IndependentCompensation Committee?Company Compensation Philosophy
  5. 5. • Types of Executive Compensation• Decision Makers/Fiduciary Considerations• Valuation Considerations• §409A and §409(p) ConsiderationsAn Overview of Executive Compensationin ESOP Companies
  6. 6. • Base Salary. Is it ever sufficient?• Short Term Cash Incentive Pay• Performance based or discretionary?• Used by 73% of survey respondents• Deferred Cash Compensation• Used by 14% of survey respondents• Equity or Synthetic Equity – Long Term Incentive• Used by 18% of survey respondents• Benefits, Perks & IntangiblesComponents of Executive Compensation
  7. 7. • Stock Options• Incentive Stock Options• Nonqualified Stock Options• Restricted Stock/Restricted Stock Units• Phantom Stock• Stock Appreciation RightsEquity and Synthetic Equity Plans
  8. 8. • Basic Issues:• How Much? ESOP share dilution• What Kind of Equity?• One Time Grant or Annual Grants?• Vesting & Exercise Periods• Restrictions on Transferability• Stock Valuation• Accounting and Tax ImplicationsEquity Incentive Plan Design
  9. 9. • Board of Directors – Independent Directoror Committee?• Officers• ESOP Trustee – Should Be Independent?• ESOP Advisory CommitteeA Look at Decision Makers/Fiduciaries
  10. 10. • Desirable to use ESOP valuation to valuestock for equity plans• With ESOP trustee’s consent, equity plandocument is to provide that ESOPvaluation is to be used for administeringequity plan• Economic dilution and impact uponcompany financial statements will beaddressed elsewhereValuation Considerations
  11. 11. Deferred Compensation & §409A• Applies to all deferred compensationarrangements• Plans that provide for payment of compensationin later tax year• Defines operational requirements fordistributions and elections• Does not apply to short term deferrals or safeharbor severance arrangements
  12. 12. Deferred Compensation & §409A• §409A does not apply to:• Incentive Stock Options• Nonqualified Options or Stock AppreciationRights granted at FMV with no other deferralfeatures• §423 Employee Stock Purchase Plans• Restricted Stock or Restricted Stock Units• Grandfathered arrangements, such as stockrights granted and vested before December 31,2004
  13. 13. Penalties for Violation of §409A• Stock rights or other equity awards subject to§409A must comply or else—• Failure subjects award holder to income taxationupon vesting, plus• 20% penalty tax and interest• Violation subjects company to potential taxwithholding penalties
  14. 14. S Corporation ESOP Anti-Abuse Rules Under §409(p)• §409(p) designed to prevent S ESOPs from being usedprimarily to benefit a few individuals• §409(p) limits amount of synthetic equity or otherdeferred pay an employee can receive in an S ESOP• ESOP holding shares of S corporation is prohibited fromallocating employer securities to “disqualifiedindividuals” during any “nonallocation year”, i.e., yearwhere no allocation is permitted
  15. 15. S Corporation ESOP Anti-Abuse Rules Under §409(p)• Who is a “disqualified person”?• (1) owner of 10% or more of “deemed-ownedshares” of corporation, or• (2) aggregate number of shares deemed owned byperson, together with shares deemed owned byfamily members, equal at least 20% of total deemed-owned shares
  16. 16. S Corporation ESOP Anti-Abuse Rules Under §409(p)• What is “synthetic equity”?• Any stock option, warrant, restricted stock, deferredissuance stock right, or similar interest or right givingholder right to receive S corporation stock in future• Includes stock appreciation rights, phantom stockunits, and similar rights to future cash payments basedon value of stock• Includes deferred compensation arrangements even ifnot payable in stock nor calculated by reference tovalue of stock
  17. 17. S Corporation ESOP Anti-Abuse Rules Under §409(p)• What is “deemed ownership”?• ESOP participant in S corporation is deemed toown allocated and unallocated shares of hisESOP account• Holder of “synthetic equity” in S corporation isdeemed to own shares of stock on which thesynthetic equity is based• Shares held outside the ESOP are not “deemed-owned shares”
  18. 18. S Corporation ESOP Anti-Abuse Rules Under §409(p)Special Rule Relating to Voting Rights:•If synthetic equity right includes right to S corporationstock having greater voting rights than shares held byESOP, the number of deemed owned shares will beadjusted upward accordingly•For example: If shares of S corporation stock held by anESOP are entitled to one vote per share, then an individualwho holds an option to purchase one share with 100 votesis treated as owning 100 shares of synthetic equity
  19. 19. S Corporation ESOP Anti-Abuse Rules Under §409(p)• Prohibited allocations made to disqualified persons:• Subject company to excise tax equal to 50% ofamount of prohibited allocations, and• Shares of disqualified persons treated as distributedand thus subject to tax• ESOP may be disqualified (endangering S election)• Shares actually owned and “deemed-owned” shares(with family attribution) are counted
  20. 20. S Corporation ESOP Anti-Abuse Rules Under §409(p)• Ascertaining whether S corporation is subject to§409(p) requires complex analysis• Draconian consequences in the event of §409(p)violation requires S corporations with ESOPs toexercise extreme caution and vigilance when issuingequity or synthetic equity, and when administeringequity based plans or programs• Goal is to prevent individual from becomingdisqualified person and thus avoid a nonallocationyear
  21. 21. Dan Janich is an Officer of Greensfelder, Hemker & Gale, P.C. inChicago whose law practice is in the areas of employee benefitsand executive compensation. His clients are businesses, includingESOP companies, as well as executives and other professionals.He has extensive experience designing and implementing equitycompensation plans, negotiating executive compensationagreements, and litigating ERISA and other benefit and executivecompensation related claims.Dan received his Bachelor of Arts degree from Marian University.He earned a Juris Doctor degree from The John Marshall LawSchool, and a Masters of Law in Taxation degree from DePaulUniversity. He is a past member of the Board of Directors of theNational Center for Employee Ownership. Further biographicaldetails are available at http://www.greensfelder.com.Daniel N. Janich
  22. 22. To ensure compliance with requirementsimposed by the IRS, we inform you that anyU.S. federal tax advice contained in thiscommunication is not intended or written tobe used, and cannot be used, for the purposeof (i) avoiding penalties under the InternalRevenue Code or (ii) promoting, marketing orrecommending to another party anytransaction or matter addressed within.IRS Circular 230 Disclosure