Employee equity incentives

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Employee equity incentives

  1. 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
  2. 2. What Considerations Typically Influence Plan Design?June 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  3. 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 planningJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  4. 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. 5. Legal Form of the Company  Sole Proprietorship  Partnership  General  Limited  Corporation  S Corporation  C Corporation  Limited Liability Company  Limited Liability Partnership  Professional BusinessesJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  6. 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. 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. 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 CompanyJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  9. 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. 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. 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 gainsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  12. 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. 13. Specific Plan Design IssuesJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  14. 14. Types of Plans  Direct Stock Purchases  Stock Options  Phantom Stock and Share Appreciation RightsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  15. 15. Direct Stock PurchasesJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  16. 16. Eligibility and Participation  Typically, individual-based approach  Potentially, broad-based approach via stock purchase planJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  17. 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 securitiesJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  18. 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 rightsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  19. 19. Type of Grant  Unrestricted  Not subject to forfeiture  Restricted  Subject to forfeitureJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  20. 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 treatmentJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  21. 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. 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 consideredJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  23. 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 noteJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  24. 24. Vesting  Passage of Time  Performance Based  Individual Performance  Company Performance  Combination of Time and Performance Vesting  Acceleration of Vesting  Determination of Triggers  Accounting ConsiderationsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  25. 25. Purchase Price  Subject to securities requirements and tax issues, no restrictionsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  26. 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 agreementJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  27. 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 statementsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  28. 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 monthsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  29. 29. Stock OptionsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  30. 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 planJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  31. 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 securitiesJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  32. 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 rightsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  33. 33. Size of Option Grant  Typically, left to the discretion of the boardJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  34. 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 optionJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  35. 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 optionsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  36. 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 priceJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  37. 37. Tax Treatment (cont.)  [Potentially] subject to deferred compensation taxation (accelerated taxation, interest charge and 20% excise tax) if exercise price < FMVJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  38. 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. 39. Vesting  Passage of Time  Performance Based  Individual Performance  Company PerformanceJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  40. 40. Vesting (cont.)  Combination of Time and Performance Vesting  Acceleration of Vesting  Definition of Triggers  Accounting ConsiderationsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  41. 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 exercisedJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  42. 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 consideredJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  43. 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 PropertyJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  44. 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 agreementJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  45. 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 statementsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  46. 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. 47. Phantom Stock and Share Appreciation RightsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  48. 48. Eligibility and Participation  Typically, individual-based approach  Potentially, broad-based approach through planJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  49. 49. Size of Grant  No restrictionsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  50. 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 applyJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  51. 51. Accounting Treatment  Benefits must be entered as an expense and book liability for accounting purposes when and as accruedJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  52. 52. “Exercise Price”  No restrictionsJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  53. 53. “Payment for Shares”  No actual payment is made  Employee receives cash award equal to difference between unit value and FMVJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  54. 54. Voting Rights  NoneJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  55. 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 issuesJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  56. 56. Questions?June 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP
  57. 57. Thank you! Bart Greenberg Haynes and Boone, LLP (949) 202-3037 bart.greenberg@haynesboone.comJune 3, 2010 Employee Equity Incentives© 2010 Haynes and Boone, LLP

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