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

1. 22nd Annual NASPP Conference – 2014 Las Vegas
22nd Annual NASPP Conference
September 29 – October 2, 2014

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
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[JG & Associates]

3. 22nd Annual NASPP Conference – 2014 Las Vegas
Agenda
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• 280G Primer
• Structuring Incentive Plans
• Jeremy Slides (
• Using Non-Competes

4. 22nd Annual NASPP Conference – 2014 Las Vegas
IRC Section 280G in a Nutshell
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“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. 22nd Annual NASPP Conference – 2014 Las Vegas
The Basic Construction of IRC Sections
280G and 4999
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Corporation/Change in Control
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Who is a DI & What is a Parachute
Payment?
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Calculating The Excess Parachute
Payment:
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
How to Value Equity that Vests Upon a
CIC?
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Private Corporation – Shareholder
Approval Exception
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
280G Planning
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Dave You are probably best suited to work up a
few slides here
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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. 22nd Annual NASPP Conference – 2014 Las Vegas
280G -- Hot Topic
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Using Non-Competes to Reduce 280G
Exposure
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• What The Regulations Provide
• The Business Valuation
• Don’t Forget Reasonable Compensation
• The Interview Process
• Legal Considerations
• Structuring Agreements

15. 22nd Annual NASPP Conference – 2014 Las Vegas
Valuing Non-Competition Provisions - The Regs.
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Valuing Non-Competition Provisions –
Business Valuation
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Valuing Non-Competition Provisions – Business
Valuation (Continued)
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– 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Valuing Non-Competition Provisions –
Reasonable Compensation
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Reasonable Compensation for Post CIC Services
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Reasonable Compensation for Post CIC Services
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Reasonable Compensation for Post CIC Services
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
State Law – Enforceability of Non-
Competes
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
State Law – Enforceability of Non-
Competes
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– 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Structuring Non-Competition Provisions
/Agreements
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• 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. 22nd Annual NASPP Conference – 2014 Las Vegas
Questions?
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26. 22nd Annual NASPP Conference – 2014 Las Vegas
Contact Us
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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