US and Canadian compensation issues for emerging and high growth companies (ehg lunch feb 2018)

Osler, Hoskin & Harcourt LLP
Lynne Lacoursière
US and Canadian Compensation Issues for
Emerging and High Growth Companies
February 2018

US AND CANADIAN COMPENSATION ISSUES FOR EMERGING AND HIGH GROWTH COMPANIES
Agenda
• Commonly Used Equity Awards
• Principal Terms of Equity Incentive Plan
• Considerations on a Change of Control or IPO
• Taxation of employment income in Canada
• Deferred compensation – Section 409A of the Code
• Taxation of Commonly Used Equity Awards
◦ Stock options
◦ RSUs/PSUs
◦ DSUs
◦ Restricted Shares
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Commonly Used Equity Awards
• Stock options: right to purchase shares at a specified price
• Restricted share units (RSUs) and Performance share units (PSUs): a right to
receive shares or a cash payment equal to the value of a share
• Deferred share units (DSUs): right to receive cash payment equal to the
value of a share
• Restricted shares: a grant of shares subject to vesting/transfer restrictions

Principal Terms of Equity Incentive Plan
• Share reserve – 10-20% pool depending on stage of company
◦ Often replenished with each round of outside investment
• Shares subject to awards – use one series of common shares (voting) for
founders, use another series of common shares (non-voting) for equity
awards
• Type of plan – simple option plan, or omnibus plan
• Eligible participants – employees, directors, consultants
• Exercise price of Option – FMV on date of grant (more flexibility for CCPC
options)
◦ Valuation
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Principal Terms of Equity Incentive Plan
• Vesting – For employees, 25% after 1 year, 1/48 each month thereafter. For
advisors/directors, 3 month cliff, 1/24 each month thereafter
◦ For cash settled RSUs/PSUs, vesting within the three year deferral period
◦ For PSUs, consider applicable performance metrics
• Option Term – 10 years most common (some as low as 5-7 years). Issue from US
perspective to increase the length of the term for options (tax issues), so better to have
longer period
• Post-termination exercisability – seeing longer period for vested options as long as not
terminated for cause. Can vary, however (may be as short as 30 days – though if
terminated for cause, then all forfeited). Shares acquired upon exercise of options may be
subject to repurchase right for specified period post-termination (see whether they violate
any non-compete). Shares typically repurchased for FMV, though if terminated for cause,
may be repurchased at lesser of cost and FMV
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Principal Terms of Equity Compensation Plan
• Restrictions on transferability
• Dividend equivalent rights for RSUs/PSUs/DSUs
• Adjustments of awards in connection with a corporate event
• Amendments
• Shareholder agreements, voting agreements, drag along
• Net-settlement/cashless exercise – helps employees exercise without coming up
with cash. Impact if CCPC options or ISOs.
◦ Consider whether to require cash to cover applicable withholding taxes
• Change of control

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Change of Control
• Single trigger – all awards are accelerated and exercised or cashed out in
transaction
◦ Automatic vs. discretionary
• Double-trigger – awards are assumed or substituted by successor entity
and vesting only accelerates if terminated without cause/constructively
dismissed within 12-24 months following change of control

280G – Golden Parachutes
• U.S. tax laws discourage companies from making large payments to
executives in connection with a change of control
◦ Corporation is denied deduction for excess parachute payments (280G)
◦ Individual subject to 20% excise tax on excess parachute payments (4999)
• No equivalent in Canada but beware as 280G and 4999 are enforced
independently
◦ U.S. taxpayer could be subject to excise tax even if foreign company undergoing
the change of control is not subject to U.S. tax
• Important shareholder approval exception for private companies
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IPO
• Exercise price of stock options granted within three months of filing of
preliminary prospectus (TSX rules)
• Grandfather pre-IPO plans, adopt new plan that meets requirements for
security-based compensation arrangements (TSX), or rules of applicable
exchange
• ISS/Glass Lewis/corporate governance practices

Taxation of Employment Income – Canada
• General rule – employment income is taxed when it is received by the
employee
• Exception to the general rule – salary deferral arrangement (SDA)
◦ Amounts deferred under an SDA are included in income in the current year
• Incentive arrangements are designed to fit within statutory or
administrative exception to the SDA rules
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Deferred Compensation – Section 409A of the Code
• Section 409A imposes comprehensive rules on the taxation of non-
qualified deferred compensation
◦ Deferred compensation is broadly defined and can include certain forms of
equity compensation
◦ Significant penalties imposed on individual if requirements of 409A are not met
◦ Specific requirements for the timing of deferral elections and the designation of
the time and form of payment
◦ 409A applies globally to all individuals subject to U.S. taxation
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Stock Options - Canada
• Stock options granted to employees or directors governed by Section 7 of
the ITA – an agreement to sell or issue shares
• No tax on grant or vesting
• Taxed on the “stock option benefit” – the difference between the exercise
price and FMV of shares at time of exercise
• Corporation not entitled to a deduction in respect of the stock option
benefit
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CCPC Stock Options - Canada
• If the corporation is a CCPC at the time the stock option is granted, the
stock option benefit is calculated at the time of exercise, but is not included
in income until underlying shares are sold
• If shares acquired upon exercise are held for 2 years, only 50% of the stock
option benefit is subject to tax
◦ 50% deduction available even if the exercise price is less than FMV
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Non-CCPC Stock Options – Canada
• If corporation is not a CCPC at the time the stock option is granted or is a
CCPC but the 2 year hold period is not met, 50% deduction may be
available if the following requirements are met:
◦ Exercise price cannot be less than the FMV of the underlying shares on the date
of grant
◦ Must acquire “prescribed shares” – beware of share terms/repurchase rights
that can impact prescribed share status
◦ Employee must deal at arm’s length with corporation immediately after grant
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Stock Options – U.S.
• Consider whether any option holders are U.S. taxpayers
• Incentive stock options (ISO)
• Non-qualified stock options (NQO) – any option that doesn’t qualify as an
ISO
• Consider U.S. securities laws exemptions if options granted to U.S.
residents
◦ Federal - Rule 701
◦ State - Blue sky laws
• Consider whether shareholder approval of the plan is required
◦ ISOs
◦ Blue Sky laws – ex. California

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ISOs – U.S.
• Similar to CCPC options, employee not taxed until underlying shares are
disposed and employee gets capital gains treatment if hold period met
◦ Employee must hold the shares for at least 2 years from the date of grant and 1
year from the date of exercise
• Terms of options must meet technical requirements under Section 422 of
the Code
• Employer not entitled to tax deduction unless employee has a disqualifying
disposition
• Be aware of shareholder approval requirement – each time number of
shares available for issuance under ISOs increases, shareholder approval is
required for plan to retain ISO status
• Modifications result in loss of ISO status

Non-qualified stock options – U.S.
• Taxed at exercise, no favourable capital gains rate
• Typically structured as exempt from 409A
◦ Option to acquire common stock of a corporation that is in a parent-sub chain
and employee is located at or below the corporation issuing the option
◦ Exercise price may never be less than FMV of the underlying shares on the date
of grant
◦ Beware of features, impact of modifications
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RSUs/PSUs – Canada
• Cash-settled RSUs/PSUs designed to fit within the 3 year bonus exception
to the SDA rules
◦ Maximum deferral period is determined based on the year of service
• Treasury-settled RSUs/PSUs are designed as Section 7 awards (zero exercise price
stock option)
◦ Can have a longer deferral period than cash-settled RSUs/PSUs
◦ If CCPC, then 50% deduction available if shares acquired upon settlement of
RSUs/PSUs are held for 2 years
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RSUs and PSUs – U.S.
• RSUs/PSUs may be exempt from 409A or subject to 409A
• Exempt RSUs/PSUs are structured as short-term deferrals – payment made
within 2 ½ months following the end of the year the awards are no longer
subject to substantial risk of forfeiture
• Key 409A trap is treatment upon termination of employment
◦ Acceleration of vesting or continued vesting upon retirement or other good
leaver provisions
◦ Continued vesting upon termination without cause
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DSUs
• Canada – structured to meet the requirements of Regulation 6801(d)
◦ Must reference shares of a corporation
◦ Any election to defer must be made before employee/director is in constructive
receipt
◦ Payment can only be made after retirement or loss of office or employment
• U.S. – subject to 409A
◦ Strict rules on timing of any election to defer
◦ Payment upon separation from service, fixed payment schedule
• Beware of separation from service/interplay with Regulation 6801(d) for
individual subject to both Canadian and U.S. taxes
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Restricted Shares
• Canada – not as commonly used as compared to the U.S. because of different tax
treatment
◦ If restricted shares are granted by non-CCPC, employee is taxed on the value of the
restricted shares at the time of grant. If the restricted shares are forfeited, employee has a
capital loss, which can’t be used to offset employment income.
◦ If restricted shares are granted by CCPC, value of the benefit is calculated at the time the
shares are acquired, but is not included in income until the shares are sold.
• If shares are held for 2 years, only 50% of the benefit is subject to tax
• U.S. – under Section 83, grants of restricted shares are not taxed until vesting
◦ Exception – employee can make a section 83(b) election to be taxed at time of grant, and
future appreciation will be taxed as capital gain
• Election must be made within 30 days of receipt of shares – this is a hard deadline
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New Section 83(i) of the Code
• The Tax Cut and Jobs Act added a new Section 83(i) of the Code which
provides for tax deferral for certain private company awards
◦ Non-executives at private companies that implement broad-based employee
equity award programs may elect to defer tax on stock received on exercise of
NQOs or on settlement of RSUs for up to 5 years
◦ Broad-based plan is one in which the employer makes the relevant class of
award available to at least 80% of its U.S. employees on equivalent terms (based
on the ratio of the employee’s award value and annual compensation)
◦ Deferral is not available to certain executives
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Thank You!
Lynne Lacoursière
Partner, Corporate
llacoursiere@osler.com
416.862.4719

US and Canadian compensation issues for emerging and high growth companies (ehg lunch feb 2018)

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