Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.

22nd Annual NASPP Presentation - 2014

1,972 views

Published on

A Discussion of the following:
Structuring Incentive Plans, 280G Primer, Using Non-competes - by Jeremy Goldstein of JLG & Associates LLC

Published in: Law
  • Be the first to comment

  • Be the first to like this

22nd Annual NASPP Presentation - 2014

  1. 1. 22nd Annual NASPP Conference – 2014 Las Vegas 22nd Annual NASPP Conference September 29 – October 2, 2014
  2. 2. 22nd Annual NASPP Conference – 2014 Las Vegas Happy 30th Birthday 280G – The IRS Code Section Which Has Not Aged Gracefully. Jeremy Goldstein, Jeremy L. Goldstein & Associates LLC Shari Overstreet, McLean Group David Schmidt, Gallagher/James F. Reda & Associates Laurence Wagman, Golden Parachute Tax Solutions LLC 2 [JG & Associates]
  3. 3. 22nd Annual NASPP Conference – 2014 Las Vegas Agenda 3 • 280G Primer • Structuring Incentive Plans • Jeremy Slides ( • Using Non-Competes
  4. 4. 22nd Annual NASPP Conference – 2014 Las Vegas IRC Section 280G in a Nutshell 4 “Congress 20 years ago inflicted on an otherwise near-perfect Internal Revenue Code section 280G and section 4999, the golden parachute penalty tax provisions1 ” IRC Sections 280G and 4999 turn 30 this year! 1 Rocap, Donald E., Levin, Jack S. and Ginsburg, Martin D., Revisiting Golden Parachutes. Tax Notes, Vol. 102, No. 2, January 12, 2004. Available at SSRN: http://ssrn.com/abstract=486145
  5. 5. 22nd Annual NASPP Conference – 2014 Las Vegas The Basic Construction of IRC Sections 280G and 4999 5 • IRC Section 280G imposes a dual penalty on so-called “excess parachute payments”: • Disallows a deduction for “excess parachute payments” paid to a “disqualified individual” (“DI”) that is “contingent” on a “change in ownership or control” of a corporation • Imposes an excise tax of 20% on Dis • When a DI (employee, independent contractor or shareholder who is subject to the golden parachute rules) receives payments or benefits on account of a Change in Control which equals or exceeds three times his/her average taxable compensation (“base amount”) for the 5 years preceding the year of the CIC (e.g. the “threshold”) an excise tax is imposed on the amount of CIC payments and/or benefits which exceed one times his/her “base amount”. (Internal Discussion: Jeremy: Perhaps a good Transition for discussion of Directors)
  6. 6. 22nd Annual NASPP Conference – 2014 Las Vegas Corporation/Change in Control 6 • Requires a “Corporation”. – Does not apply to Partnerships, S-Corps and LLCs taxed as partnerships (but beware if corporations within the chain) – Applies to both public and private corporations • What’s a Change in Ownership or Control? – Person or group acquires more than 50% of the total fair market value or total voting power of the stock of the Corporation – During a 12-month period, the sale of a substantial portion (1/3 or more) of the fair market value of the Corporation’s assets – Person or group acquires more than 20% of the voting power of the stock of the corporation in a 12 month period (effective control) – Majority of board members replaced (effective control)
  7. 7. 22nd Annual NASPP Conference – 2014 Las Vegas Who is a DI & What is a Parachute Payment? 7 • Disqualified Individuals (“DI”) – A DI includes any persons who are - – Shareholders –must hold at least 1% of the fair market value of outstanding shares of the corporation • Vested stock options count – Officers - up to 10% of the total employee population (minimum of 3; maximum of 50 officers) – Highly Compensated Individuals – highest paid 1% of the employee population (up to 250) with annualized compensation in excess of $115,000 • Parachute Payments - Generally a parachute payment is a payment that would not have been made in the absence of a CIC Common parachute payments include: – Severance, Deal Bonus – Health & welfare benefits received during severance period – Unvested payments (such as options, restricted shares, long term incentive plans, or other retirement plans) which receives accelerated vesting on the CIC – Additional pension credits – Pro-rated annual bonuses
  8. 8. 22nd Annual NASPP Conference – 2014 Las Vegas Calculating The Excess Parachute Payment: 8 • Excess Parachute Payment” exist if the present value of all CIC payments made or to be made to the particular individual equals or exceeds three times the individual's "base amount“ – Base Amount = average 5 years taxable compensation – Safe Harbor = 3 times base amount less $1 – Excess Parachute Payment = the amount which the actual value (as opposed to present value) of the parachute payment exceeds 1 times the base amount
  9. 9. 22nd Annual NASPP Conference – 2014 Las Vegas How to Value Equity that Vests Upon a CIC? 9 • Performance-Based Vesting - In general, if an unvested payment vests as a result of a CIC, and normal vesting was based on performance criteria, the entire payment will be a parachute payment. • Time-Based Vesting - In general, if unvested property vests as a result of a CIC, and normal vesting was solely time-based, the parachute amount of the payment is calculated as follows: • The present value of receiving such payment early; plus • The “lapse of obligation factor” which equals 1% multiplied by the number of full months of acceleration (for which the DI is no longer required to render services to receive such payment) – For example, if a DI receives a payment a full 6 months early, the lapse of obligation factor is 6% of the total payment
  10. 10. 22nd Annual NASPP Conference – 2014 Las Vegas Private Corporation – Shareholder Approval Exception 10 • If the stock of the corporation is not publicly-traded: – Shareholders may be allowed to vote on the payments – Vote must pass by 75% of shareholders entitled to vote – The vote can be on part of the payments • Can be separate votes for each DI, or a single vote on all payments to all DI’s – The CIC cannot be contingent on the outcome of the vote – Entity shareholders – pass through voting – The vote must take place among shareholders of record determined no earlier than 6 months before the CIC – Adequate disclosure about all material facts about the payments to all shareholders entitled to vote • DIs who would receive payments are not permitted to vote on the matter • Vote must determine the right of the DIs to receive or retain the payments (i.e., the DIs must agree to waive the payments if the requisite vote is not attained)
  11. 11. 22nd Annual NASPP Conference – 2014 Las Vegas 280G Planning 11 • Cutting back payments to safe-harbor, • Increasing the executive’s base amount • Post closing transition/consulting arrangements • Ascribing Value to Non-Competition Provisions • Restructuring Long-Term Incentives Awards: – Consideration of reworking equity plan so that vesting is based on performance (short term vesting if performance achieved) and time vesting (longer term, rather than just the standard performance cycle). Not suitable for Section 162(m) performance-based plans – Where Me performance feature is based on shorter measurement periods • Reasonable Compensation for Pre-Change in Control Services
  12. 12. 22nd Annual NASPP Conference – 2014 Las Vegas Dave You are probably best suited to work up a few slides here 12 Part II: - [This is from our proposal] • Equity plan construction – here we will discuss how 280G should be considered when structuring equity plans; specifically how vesting criteria (time versus performance) can adversely affect 280G. Moreover we will suggest alternative structures which may help reduce 280G exposure. This is an area that we will highlight (25-30 minutes)
  13. 13. 22nd Annual NASPP Conference – 2014 Las Vegas 280G -- Hot Topic 13 • Current M&A environment often driven by activist investors • Transaction often preceded by proxy contest in which activist slate is placed on board • CEOs often fired and replaced by board member supported by activist who drives sale process • As board compensation counts toward “safe harbor” and is often less than compensation as employees, new CEO safe harbor may be low • Planning at the time the board member assumes the role of CEO is therefore of paramount importance • Upfront grants, non-competes, sign on bonuses, 83(b) elections, gross- ups, time-based equity grants
  14. 14. 22nd Annual NASPP Conference – 2014 Las Vegas Using Non-Competes to Reduce 280G Exposure 14 • What The Regulations Provide • The Business Valuation • Don’t Forget Reasonable Compensation • The Interview Process • Legal Considerations • Structuring Agreements
  15. 15. 22nd Annual NASPP Conference – 2014 Las Vegas Valuing Non-Competition Provisions - The Regs. 15 • Compensation paid for a restrictive covenant, such as a covenant not to compete is not a parachute payment (to the extent the executive can demonstrate that such payments are “reasonable compensation” for future services) – Under Treas. Reg. §1.280G-1 Q/A 40-42, where an executive can demonstrate that payments made after a CIC are reasonable compensation for services rendered after the CIC, such payments are not included. The regulations specifically provide (Q/A 42(b)), that an example of such services include refraining from performing services (e.g. , a covenant not to compete) – Treas. Reg. §1.280G-1 Q/A 42(b) also provides that the executive must demonstrate by clear and convincing evidence that the agreement substantially constrains the executive’s ability to perform services, and there is a reasonable likelihood that the agreement will be enforced.
  16. 16. 22nd Annual NASPP Conference – 2014 Las Vegas Valuing Non-Competition Provisions – Business Valuation 16 • The value of a non-compete agreement is typically derived from estimating the potential impact of competition stemming from: – Reductions in revenue – Increases in expenses – Changes in working capital needs, or – Anything that could otherwise reduce the cash flows of the business – Additionally, the valuation contains subjective estimates for the probability of competition, which is typically based on factors such as the ability, willingness, age, health and financial position of the potential competitor and factors relating to his or her industry.
  17. 17. 22nd Annual NASPP Conference – 2014 Las Vegas Valuing Non-Competition Provisions – Business Valuation (Continued) 17 – All non-compete analyses should address three key concerns addressed in Revenue Ruling 77-403 – Whether, in the absence of the covenant, the covenanter would desire to compete with the covenantee; – The ability of the covenanter to compete effectively with the covenantee in the activity in question; and – The feasibility, in view of the activity and market in question, of effective competition by the covenanter within the time and area specified in the covenant – Additionally, the covenanter’s economic resources, business expertise in the industry, contacts and relationships with customers, suppliers, and other business contacts, and the buyer’s interest in eliminating competition should be considered during the valuation process. [Shari lets beef this up a little more; I know you took notes during the last presentation]
  18. 18. 22nd Annual NASPP Conference – 2014 Las Vegas Valuing Non-Competition Provisions – Reasonable Compensation 18 • In addition to the business valuation, the valuator must also consider what constitutes “reasonable compensation” • Applying a business valuation methodology without a compensation analysis will likely not withstand the scrutiny of an IRS audit • The 280G regulations are vague in describing what constitutes reasonable compensation for purposes of a non-competition arrangement • Absent specific guidance, a reasonable approach is to follow the IRS guidance for determining reasonable compensation in an active services role • Under the 280G regulations, reasonable compensation consists of “total compensation” and is based in part, on the nature of services to be rendered, the executive’s historic compensation for performing such services, and the compensation of individuals performing comparable services in situations in which the compensation is not contingent upon a CIC [see Treas. Reg. §1.280G-1 Q/A 40(a)]
  19. 19. 22nd Annual NASPP Conference – 2014 Las Vegas Reasonable Compensation for Post CIC Services 19 • If an executive is compensated with respect to services rendered after a CIC, such services are not parachute payments provided the executive can demonstrate by clear and convincing evidence that such payments represent “reasonable compensation” for such services. • Under the 280G regulations and related case law, reasonable compensation consists of total compensation and is based in part, on the nature of services to be rendered, the executive’s historic compensation for performing such services, and the compensation of individuals performing comparable services in situations in which the compensation is not contingent upon a CIC. • If an executive enters into such an arrangement, the executive MUST PERFORM SUCH SERVICES, in order to exclude amounts paid for such services. – The issue of post-CIC services was litigated in Square D. Company and Subsidiaries v. Commissioner 121 TC 168 (“Square D”). – Most common example of such an arrangement is where a company and executive enter into a post CIC consulting arrangement or provide a retention bonus (e.g., Square D case). – Square D states that the “statute provides that such payments are presumptively unreasonable compensation
  20. 20. 22nd Annual NASPP Conference – 2014 Las Vegas Reasonable Compensation for Post CIC Services 20 • How is total compensation defined? • 280G does not provide a definition although 280G uses “payment” language • The Square D case did provide some guidance as follows (note-this case was a look-back in time such that compensation was generally based on what was earned/paid): – salary paid; – bonuses earned; – treat the LTIP payouts as earned ratably over the 3-year period covered by the LTIP arrangements; – perquisite value received. • Translation of Square D findings into practical use: – Calculations often need to be completed before the taxable year for the CIC is complete therefore; • when calculating reasonable compensation use target compensation data. – Include perquisite values.
  21. 21. 22nd Annual NASPP Conference – 2014 Las Vegas Reasonable Compensation for Post CIC Services 21 • Historic Compensation – Value ascribed long-term incentives should be recognized ratably. – Square D did not directly opine on the stock option valuation methods but stated that the expert witness for IRS “used non-standard methods” for valuing stock options as compared the valuation used by the petitioners—we believe this suggests the use of Black-Scholes (or comparable models) is appropriate. • Market Compensation – Square D reinforces the 280G guideline for use of “similarly situated employees” working for “comparable employers” as a means of determining reasonable compensation – Square D standard is slightly different than what is typically used be executive compensation consultants. – Only use substantially similar companies for peer analysis. – Size of peer group less important in Square D; where no peer data available court based reasonable compensation on historical compensation. – Broad based survey data was not accepted in Square D case. – 90th Percentile acceptable if justified by facts.
  22. 22. 22nd Annual NASPP Conference – 2014 Las Vegas State Law – Enforceability of Non- Competes 22 • Non-competition agreements must be legally enforceable to have any value for purposes of 280G – Enforceability of restrictive covenants is dependent on state law – For example, non-competes generally are not enforceable in CA (few exceptions apply). – Courts typically review the scope of the non-compete: • Activities covered • Geographic area covered • Duration • [Jeremy Next 3 slides are good slides for you to cover & modify; previously covered by Susan Dixon]
  23. 23. 22nd Annual NASPP Conference – 2014 Las Vegas State Law – Enforceability of Non- Competes 23 – In many other jurisdictions, non-competes must be drafted carefully to be enforceable. • Courts in many states may “blue pencil” (i.e., reduce the scope) of a non-compete to make it enforceable) • Other courts may refuse to “blue pencil” a non-compete agreement. If the non-compete is overly-broad as written, the court will determine it is void in its entirety. • Other Considerations – Enforceability – Clawbacks – State Law/Multiple jurisdictions
  24. 24. 22nd Annual NASPP Conference – 2014 Las Vegas Structuring Non-Competition Provisions /Agreements 24 • Employment or CIC Agreements that provide severance should include post-termination non-competition restrictions – From a 280G valuation perspective, it may be helpful to designate a separate amount of consideration for the non-compete obligation, rather than subsuming that consideration within the severance amount – On the other hand, if a specific amount is designated to the covenant in the agreement, that reduces flexibility to assign a greater value to it at the time of a CIC if parachute payments exceed the threshold amount by more than anticipated • Ideally, non-competition payments should be periodic, rather than lump sum, as it is much easier to demonstrate that the non- competition covenant is likely to be enforced where the agreement provides the company the ready ability to stop payment in the event of any breach
  25. 25. 22nd Annual NASPP Conference – 2014 Las Vegas Questions? 25
  26. 26. 22nd Annual NASPP Conference – 2014 Las Vegas Contact Us 26 Jeremy Goldstein Founding Partner Jeremy L. Goldstein & Associates, LLC jeremy.goldstein@jlgassociates.com Shari Overstreet Managing Director The McLean Group, LLC soverstreet@mcleanllc.com David Schmidt Senior Consultant, Executive Compensation Consulting Arthur J. Gallagher & Co. david_schmidt@ajg.com Laurence Wagman Founding Principal Golden Parachute Tax Solutions, LLC lwagman@280GSolutions.com

×