Tax Obstacles and Optimization Guidance for Employee Benefits - PowerPoint PPT Presentation

Presenting a live 90-minute webinar with interactive Q&A Structuring Management Carve-Out Plans for Privately Held Corporations: Mechanics, Tax Obstacles and Optimization Guidance for Employee Benefits Counsel on Private Company Liquidity Bonus Plan Compensation Arrangements WEDNESDAY, MARCH 23, 2016 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Elizabeth A. Gartland, Esq., Fenwick & West , San Francisco Marshall Mort, Esq., Fenwick & West , Mountain View, Calif. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 . NOTE: If you are seeking CPE credit, you must listen via your computer — phone listening is no longer permitted.

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Structuring Management Carve-Out Plans for Privately Held Corporations Elizabeth Gartland, Marshall Mort March 23, 2016

Introduction  Today, we will discuss Carve-Out Plans for privately held corporations. We will discuss: • Structure, including mechanics and common characteristics • Key tax and legal considerations • Current trends 6

What is a Carve-Out Plan?  A Carve- Out Plan “carves out” value that would otherwise be paid to preferred shareholders in a merger transaction in order to motivate key employees to remain through the merger transaction. 7

What is the purpose of a Carve-Out Plan?  A Carve-Out Plan is a bonus plan designed to incentivize key employees in the event of a Change in Control transaction (CIC) where the equity held by the key employees is substantially underwater (i.e., of little or no economic value).  Generally, a Carve-Out Plan is used to provide incentives to retain key employees through a CIC by paying a bonus in connection with a CIC. 8

How does a Carve-Out Plan Work? Typically, a Carve-Out Plan designates either a percentage of the  aggregate consideration payable by the acquiror in the CIC, or another fixed amount, (the “Pool”) to be paid to key employees in connection with the CIC. Payment is a “debt” and thus paid before preferred shareholders.  Plan can take one of two forms:  • Carve Out Plan reserves a percentage of the “Net Proceeds” in the transaction, so each holder effectively gets a portion of that percentage • Phantom Stock; each carve out participant has the right to payout as if holding 1 or more actual shares of stock (i.e., a notional shareholder). Payment can be structured to pay on the CIC or at a future date.  9

Key Structure Considerations  Pool Size & Calculation  Form of Payments  Participants  Allocation Method & Forfeitures  Reduction of Bonus Payments  Timing & Conditions on Payments  Amendment & Termination 10

Structure – Pool Size & Calculation  Pool size varies greatly from deal to deal. • Pools ~10% of the aggregate CIC consideration is common; rarely under 5% or over 15% • The more participants, the larger the Pool  Pool may be straight % of the aggregate CIC consideration  Pool may be a sliding formula (e.g., Pool % moves up as the aggregate CIC Consideration increases), example: • Pool is 10% if aggregate CIC consideration is between $X and $Y, but pool is 12.5% if aggregate CIC consideration is between $Y and $Z  Pool may be a fixed dollar amount (more common when implemented in connection with CIC term sheet). 11

Structure – Pool Size & Calculation  Definition of aggregate CIC consideration from which the Pool is determined is important.  Typical definition is the total consideration payable to Company shareholders (i.e., the “Net Proceeds”).  The definition of “Net Proceeds” can include / exclude specific payments or liabilities, such as: • Common to exclude transaction expenses; • Common to assume that no payment is made under the Carve Out Plan itself (i.e., the Net Proceeds definition assumes there is no carve out plan); • Unusual to exclude other liabilities generally (i.e., vacation accrual or bonus accrual). 12

Structure – Pool Size & Calculation  Definition of aggregate CIC consideration from which the Pool can also include earn-outs or the escrow value (a majority of plans allow for this).  If included, the portion of the Pool attributable to the earn- out or escrow would be payable to Participants if and when paid to shareholders, subject to conditions. Recommendation – Since including earn-outs and escrow can  add complexity, consider structuring the Plan to give the Board discretion to determine whether to include earn-outs or escrow at the time of the CIC. Warning – There are 409A implications if earn-out or escrow  payments are included. 13

Structure – Form of Payments Carve-Out Plans can pay in cash or acquiror stock to reflect the structure of  the CIC (Most are drafted to accommodate both types of payments). Warning: If paid in acquiror stock, consider securities law compliance.  Will the acquiror stock need to be registered somehow if the acquiror is  public? What exemption will apply if the acquiror is a private company?  Warning: If the merger consideration is a mix of stock/cash and paid in an  earn-out, 409A implications may arise if payment is not on the same “terms and conditions” as to stockholders generally. Is the “form” of the earn -out carve out plan consideration part of the  “terms and conditions”? Some plans may require cash (to the extent there is cash in the transaction)  at closing, but that any deferred amount to cash/stock at same mix as to stockholders. Payment under a Carve-Out Plan is a taxable event and cash will be needed.  14

Structure – Participants Who?  • Can be broad-based, but typically limited to management or top employees who are key to retain through a CIC. • Plan (as approved by the Board) will include eligible classes participants (e.g., full-time employees). How?  • Board (or its delegate, often CEO) designates each participant and allocation. • Participants should sign a short participation agreement. • Less often, plans may reserve the right for a post-closing independent committee to administer the plan to avoid administration by Buyer’s board. When to designate participants and allocations?  • May be notified at time Plan is adopted (serves retention purpose) • May be notified later, and close in time to CIC (less retentive value, but increased flexibility in divvying up Pool) 15