Equity Compensation - Comparison of Plan Types: Including Stock Options, RSUs and Stock Purchase Plans

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This presentation will bring clarity to common complications and conflicts in equity compensation, including the basics of acronyms, tax rules, differences between core practice rules and regulations, benefits to employee and more.

Learn how to translate equity-specific acronyms and terms into plain English
Learn how participants make money from Appreciation Only, Full Value and Stock Purchase plans and how each can be a great or poor solution.
Learn the pros, cons and differences between commonly used equity compensation instruments. You will be surprised how similar and different they can be!

Published in: Business, Economy & Finance

Equity Compensation - Comparison of Plan Types: Including Stock Options, RSUs and Stock Purchase Plans

  1. 1. Equity Compensation for Compensation Professionals Ending the State of Confusion Marianne Snook, CEP: CEO, Stock & Option Solutions Dan Walter, CEP: President and CEO, Performensation
  2. 2. Dan Walter President and CEO Performensation Marianne Snook CEO Stock & Option Solutions Tel: +1 415 625-3406 dwalter@performensation.com www.performensation.com Tel: +1 408 979-8700 msnook@sos-team.com www.sos-team.com Dan Walter, CEP, is the President and CEO of Performensation. Dan has assisted companies with both executive and broad-based compensation programs since 1994. Dan’s expertise includes equity compensation, performance-based pay, and talent management issues. His experience with these programs includes philosophy, diagnosis, design, communication, administration, and reporting. Dan is considered an industry thought-leader for all forms of equity, including stock options, restricted shares and units, stock purchase plans, and performance-based programs. In addition to his focus on plan design, he has architected software solutions, administrative and technological best practices for these programs. With experience in human resources, payroll, and equity administration, Marianne offers a unique background that has given her the tools to identify and implement creative solutions for SOS clients. In her over 25 years in equity plan management, she has held positions as a director of a major outsourcing provider, an independent consultant, and an internal stock administrator. These experiences allow her to view all the advantages and disadvantages of various stock administration solutions. Marianne speaks on both a local and national level on various facets of stock program administration. A Certified Equity Professional, she is also an active member of the National Association of Stock Plan Professionals and the National Center of Employee Ownership.
  3. 3. Total Rewards Model LET’S PUT THEM IN FAMILIES BY SIMILAR QUALITIES Courtesy of World at Work
  4. 4. Performensation / SOS Total Equity Compensation Model
  5. 5. THESE ARE THE ACRONYMS YOU HEAR IN MEETINGS AND READ IN ARTICLES
  6. 6. SSAR CSO MSU ISO PA PSA DPP PUA NQSO MUA SA NQESPP ESPP RSU DSA RSS SAR
  7. 7. IF YOU’RE LUCKY YOU MAY ACTUALLY GET WORDS AND NAMES FOR EQUITY COMPENSATION INSTRUMENTS
  8. 8. PERFORMANCE PHANTOM STOCK AWARDS DIRECT PURCHASE PLANS CAPPED STOCK OPTIONS MARKET STOCK UNITS INCENTIVE STOCK OPTIONS NONQUALIFIED STOCK OPTIONS MEMBERSHIP UNIT AWARDS RESTRICTED STOCK SHARES STOCK SETTLED SARS IRC 423 ESPP STOCK APPRECIATION RIGHTS RESTRICTED STOCK UNITS DEFERRED STOCK PERFORMANCE UNITS STOCK AWARDS NONQUALIFIED ESPP
  9. 9. EVEN THOSE MAY NOT BE VERY HELPFUL LET’S PUT THEM IN FAMILIES BY SIMILAR QUALITIES
  10. 10. APPRECIATION ONLY STOCK OPTIONS STOCK APPRECIATION RIGHTS FULL VALUE RESTRICTED STOCK SHARES RESTRICTED STOCK UNITS PHANTOM STOCK PERFORMANCE UNITS DEFERRED STOCK STOCK PURCHASE IRC 423 ESPP NQ ESPP DIRECT PURCHASE
  11. 11. Three Main Equity Families
  12. 12. Three Main Equity Families Full Value Appreciation Purchase Restricted Stock Incentive Stock Options IRC 423 Qualified ESPP Restricted Stock Units Non-Qualified Stock Options Non-Qualified ESPP Phantom Stock Stock Appreciation Rights Direct Purchase Deferred Stock
  13. 13. STRUCTURE STRUCTURE STRUCTURE No purchase cost to participants Purchase cost set at grant date. Usually equal to stock price Purchase price based on either grant date or purchase date Generally taxed when purchase / exercise is elected, unless tax qualified Discount commonly applied to purchase price Generally taxed when restrictions end If time-based vesting: Compensation Expense = Intrinsic Value at Award Date Built-in gain works well with performance-based vesting If time-based vesting: Compensation Expense = Black Scholes value Tax qualified status available under IRC 422 Generally taxed at time of purchase, unless tax qualified Compensation Expense = Black Scholes Value of estimated shares to be purchased
  14. 14. COMPENSATION PRIORITY COMPENSATION PRIORITY Provide tangible compensation beginning the date of award Provide potential compensation beginning at grant date Provide simplified method to augment pay by purchasing shares Less dilution than appreciation grants, but same compensation cost Requires higher dilution to deliver same modeled value as full value awards Dilution can be controlled via limits, but more difficult with large companies Risk of no immediate value upon vest, or ever Low risk, generally conservative reward Potential to allow move of ordinary income to capital gains Potential to allow move of additional ordinary income to capital gain Retention focus, but only for 3-5 years No ordinary income avoidance, limited deferral opportunities COMPENSATION PRIORITY
  15. 15. FIRST SOME TERMS AND DEFINITIONS TO KEEP ALL OF US ON THE SAME PAGE
  16. 16. Option Provides the participant the option to exercise (purchase) stock at a later, generally at a price set on the grant date
  17. 17. Restricted The holder possesses stock or units (synthetic stock) that is not entirely controlled by them until the restrictions lapse (vest)
  18. 18. Disqualified Any type of equity that had a tax benefit under IRC 421-424, where the participant chose to transact the underlying shares BEFORE the prescribed tax benefit period had been met Tax benefit period is 2 years from the date of grant and 1 year from the date of exercise or purchase
  19. 19. Qualified Any type of equity that had a tax benefit under IRC 421-424, where the participant chose to transact the underlying shares only AFTER the prescribed tax benefit period had been met Tax benefit period is 2 years from the date of grant and 1 year from the date of exercise or purchase
  20. 20. Non-Qualified Any type of equity upon grant, does not meet the tax benefit rules defined in IRC 421-424 Also, any ISO or ESPP shares that, prior to exercise, do not meet ALL of the rules under IRC 421-424. Examples • Over the $100,000 Limit • Outstanding beyond 3 months of regular termination • Modified to so that grant price may not be at least 100% of Grant date FMV
  21. 21. Based on longer periods than most compensation and with no guarantees of final values, every equity award can feel like an extended journey across a sea.
  22. 22. But, all equity is not equal
  23. 23. You must always remember that the waters may not be safe, and some tools provide better protection than others
  24. 24. Take a guess at the equity instrument that creates this path
  25. 25. discount = safety limits = small gains
  26. 26. Which type of equity can provide this path?
  27. 27. $0 cost = ultimate safety no limits = big gains
  28. 28. And that leaves perhaps the best and worst tool
  29. 29. no discount = limited safety no limits + leveraged grant size = big gains (or $0)
  30. 30. SHOW ME THE MONEY, OR AT LEAST SIMPLIFY HOW IT IS MADE
  31. 31. BUT WHEN ARE SHARES ISSUED? AREN’T THESE DESIGNED TO CREATE OWNERS?
  32. 32. Nonqualified vs. Incentive Stock Options vs. Stock Appreciation Rights
  33. 33. Incentive Stock Options (ISOs) Primary Use Attract and Motivate. Retention when stock price is growing steadily. Main Features Preferential tax treatment. Limits on use. Highly Leveraged. Pays only if price increases Tax Issues No tax withholding at exercise. No Ordinary income if held for qualifying period. Not applicable to int'l participants. Alternative Minimum Tax concerns Typical Plan Sponsor Typical Recipient Pre-IPO and Publicly traded companies (high-tech/biotech and high growth sectors) Execs at all sizes, High-tech staff at Small to Mid-size companies Accounting Issues Legal Issues Complex valuation and amortization. Difficult market comparisons Limits on Grant Price, Value of Grant, Term of Grant and Term of Plan. Shareholder approval required within 12 months of BOD adoption. Communication Issues Administration Issues Difficult to show value if underwater. Leverage can be issue in highly volatile stocks. Tax issues, Dispositions, AMT Activity peaks and valleys. Grant processing. Exercise processing. Termination rules. Int'l issues. Disposition tracking.
  34. 34. Non-Qual Stock Options (NQSOs) Primary Use Attract and Motivate. Retention when stock price is growing steadily. Main Features Highly Leveraged. Guaranteed corporate tax deduction when exercised. Pays only if stock price increases Tax Issues Ordinary Income and Tax withholding at Exercise. 409A Supplemental Wages eligible ($1MM threshold). Typical Plan Sponsor Typical Recipient Pre-IPO and Publicly traded companies (all sectors) Widely used, grant size generally based on position. Consultants and Outside BOD members Accounting Issues Legal Issues Complex valuation and amortization. Difficult market comparisons. Variable Fair Value accounting for non-employee service providers. General plan documentation. Detailed documentation when used for outside BOD members. Post-termination rules and regulations. Communication Issues Administration Issues Difficult to show value if underwater. Leverage can be issue in highly volatile stocks. Tax issues at exercise. Activity peaks and valleys. Grant processing. Exercise processing. Termination rules. Int'l issues. Tax at Exercise.
  35. 35. Stock Appreciation Rights (SARs) Primary Use Attract and Motivate Main Features Can be settled in cash or stock. Provides option-like features without needing to deliver stock Tax Issues Taxed at time of exercise. Ordinary Income and Taxes must be withheld. Typical Plan Sponsor Typical Recipient Privately held companies. Including S-Corps Upper and Middle Management Accounting Issues Legal Issues Stock-settled treated like options (fixed, Fair Value accounting). Cash-settled require variable accounting (quarterly adjustment of Fair Value) Possible ERISA issues with longterm holding period on broadbased plans. Generally not deemed "stock" for S Corps Communication Issues Administration Issues Comparison to options (stock value no/no stock). Delivery of only the appreciation rather than whole grant Limited support from brokers at exercise (unlike options). Limited overall software capabilities
  36. 36. Restricted Stock Shares vs. Restricted Stock Units vs. Performance Stock Units
  37. 37. Restricted Stock Shares (RSS/RSA) Primary Use Attract and Retain. Motivation added when awarded at higher than $0 cost to participant Main Features Value if price drops. Minimally leveraged. Can be used to satisfy Executive Ownership requirements Tax Issues No income or tax until vested. 83(b) election to be taxed at award date. Sell-toCover requires sufficient trade volume. Withhold-to-cover requires sufficient corporate cash. Retirement eligibility can result in income and tax prior to retirement. Typical Plan Sponsor Typical Recipient Closely Held and Publicly traded companies (less volatile sectors) Upper and Middle Management Accounting Issues Legal Issues Simple Valuation. Value is Intrinsic value on award date. Cost essentially equivalent to paying cash. Retirement eligibility can result in accounting for expense prior to vesting completion. Communication Issues Event-based, forced income and taxation. Comparison to Options Private companies are subject to Blue Sky laws. Public companies are subject to SEC regulations at the time of award. Administration Issues Award processing. Event planning with other corporate issues. Repurchases. 83(b) elections. Dividend tracking. Share issuance at time of award.
  38. 38. Restricted Stock Units (RSU) Primary Use Attract and Retain. Motivation added when awarded at higher than $0 cost to participant Main Features Value if price drops. Minimally leveraged. Better internationally than RSS Tax Issues No income or tax until vested. Dividend Equivalents taxable unless fully restricted. Sell-to-Cover requires sufficient trade volume. Withhold-to-cover requires sufficient corporate cash. Deferral allowed with sufficient notification. Typical Plan Sponsor Typical Recipient Closely Held and Publicly traded companies (mature tech, less volatile sectors) Widely used above operational staff, often broadbased as well Accounting Issues Legal Issues Simple Valuation. Value is Intrinsic value on award date. Cost essentially equivalent to paying cash. Communication Issues Event-based, forced income and taxation. Comparison to Options 409A considerations. Registration of shares prior to award. Administration Issues Award processing. Event Planning with other corporate issues. Forfeitures. Dividend Equivalent tracking. Share movement at time of vest.
  39. 39. Performance Stock Units (PSU) Primary Use Attract and Motivate Main Features Can set thresholds to ensure payout even if performance is below expectations Excellent communication tool for high performance Tax Issues No income or tax until vested. Dividend Equivalents taxable unless fully restricted. Sell-to-Cover requires sufficient trade volume. Withhold-to-cover requires sufficient corporate cash. Deferral allowed with sufficient notification. Typical Plan Sponsor Typical Recipient Established public companies with history to support long-term goal definition. Progressive private companies Upper and Middle Management Accounting Issues Legal Issues Simple Valuation. Complex accrual. Expense booked is relative to probable payout. No expense reversal if goals are market based Communication Issues Regular communication required to drive performance. Must provide proximity to goal and what still needs to be done to attain goals 409A considerations. Registration of shares prior to award. 162(m) considerations Administration Issues Stock admin systems do not support. Dividends are difficult to track. Difficult to correctly track proximity and remaining effort to reach goals
  40. 40. THE BASICS OF OPTIONS AND SARS
  41. 41. PRICES TIME
  42. 42. THE KEY IS EXERCISING AT THE RIGHT TIME (AND THAT’S HARDER THAN IT SOUNDS)
  43. 43. THE VALUE OF NOT PAYING FOR THINGS
  44. 44. IT SEEMS PERFECT UNTIL YOU LOOK CLOSELY. MOST PEOPLE ARE CERTAIN THEY WOULD HAVE TAKEN ADVANTAGE OF THE HIGHEST PRICES!
  45. 45. WHAT ABOUT RSU VS NQSO? AN EXAMPLE OF THE COMPENSATORY DIFFERENCES
  46. 46. AND…THEY BOTH WIN, SOMETIMES
  47. 47. SO… HOW DO ESPPs WORK? (and try to be quick about it, you’re running out of time!)
  48. 48. SOME MORE ABOUT INCENTIVE STOCK OPTIONS (ISOs)
  49. 49. TAXES
  50. 50. RESTRICTED STOCK UNITS (RSUs) BRIEFLY
  51. 51. IF YOU COUNT PERFORMANCE UNITS (and we usually do) THESE MAKE UP MORE THAN 50% OF THE TOTAL REWARDS DELIVERED TO MANY EXECUTIVES
  52. 52. BUT WE ONLY GRANT NONQUALIFIED STOCK OPTIONS
  53. 53. FINANCE PEOPLE LOVE THIS!
  54. 54. EMPLOYEE STOCK PURCHASE PLANS (ESPPs). SO MANY FEATURES, SO LITTLE TIME
  55. 55. WE’RE ON A ROLE SO LET’S CLOSE THIS OUT STRONG
  56. 56. nonqualified vs. incentive stock options Corporate tax deduction built-in Very long-term Income to participant can be mostly Capital Gains Simple administration Great participant tax benefits No limits Very long-term Desired in Tech firms and start-ups No downside protection Complex rules and administration Only performance link is stock price Limits for time, shares, values, people Exercise cost can be an issue Very few use tax benefits provided
  57. 57. restricted stock awards vs. RSU Instant ownership No IRC 409A issues Most lawyers understand these Downside protection Instant owners may not fit culture Repurchase and termination issues Easy to link to performance conditions No need to issue stock until vest Potential for income deferral Admin is fairly simple Downside protection 409A issues: valuation, design, payment terms Dividend equivalent issues Inflexible participant income and taxation timing Inflexible participant income and taxation timing Perhaps too much downside protection Perhaps too much downside protection
  58. 58. IRC 423 vs. NQ-ESPP Excellent participant tax benefits Very easy and inexpensive to administer Discount does not have to = immediate income and taxes Very easy to roll-out Partially funded by participants Mostly, or totally, funded by participants Creates path to ownership Wildly flexible in design Compensation expense and accounting Any discount is taxed at time of purchase Communication must be strong Discounts generally too small to inspire broad participation Requires a system or outside administration assistance Does not work in every jurisdiction Not competitive in tech firms and postIPO companies
  59. 59. YOU HAVE QUESTIONS, WE HAVE ANSWERS
  60. 60. Dan Walter President and CEO Performensation Marianne Snook CEO Stock & Option Solutions Tel: +1 415 625-3406 dwalter@performensation.com www.performensation.com Tel: +1 408 979-8700 msnook@sos-team.com www.sos-team.com LinkedIn: www.linkedin.com/in/danwalter LinkedIn www.linkedin.com/pub/marianne-snook/4/752/427 Twitter: @performensation Twitter: @SOSXtra SOS Xtra Newsletter Performensation Blog: www.performensation.com http://sos-team.com/screens/SOS-Media/SOS-XtraNewsletter.aspx

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