Workshop 1B The Cliff Notes Guide to Equity Comp...Learn how to read your company’s charter...

Aspirations by Stock & Option Solutions Nov.4, 2014

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The Cliffs Notes Guide to Equity Comp Jeannette Wheeler, CEP, Solium

Achaessa James, CEP, NCEO/ Stock & Option Solutions

Carolyn Fox, Visa, Inc.

November 4, 2014

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� Four Core Disciplines

� Corporate Governance

� Plan Design & Administration

� Accounting & Financial Reporting

� Taxation


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� Capitalization

� Board authorization

� Shareholder approval

� Securities Regulations

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� Charter Documents

� Multiple Classes of Stock

� Common

� Preferred

� Rights and Privileges

� Voting or Nonvoting

� Dividends and liquidation preferences

� Stock Certificates

� Stock Dividends

� Stock Splits

� Par Value

� IPO stock activities


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� Board authorization� Corporate veil – corporate liability vs. personal liability

� Meeting minutes (meeting date) vs. Unanimous Written Consent

(date of last signature)

� Corporate Hierarchy� Shareholder benefit is priority

� Shareholder approval

� IPO Board Preparation (board composition, see

Appendix – Governance slide)

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� 1933 Securities Act (‘33 Register Me)

� 1934 Securities Exchange Act

(‘34 Tell Me More)


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� Exemptions from registration� Rule 701 – stock plan issuances

(3-prong test, see Appendix – Governance slide)

� Regulation D – private offerings

(investor restrictions, see Appendix – Governance slide)

� Triggers for registration of private companies� $size and #shareholders

(asset and shareholder limits, see Appendix – Governance slide)

� JOBS Act of 2012

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� Pre-IPO Securities Registration� S-1– General registration statement

� S-8 – Employee benefit plan registration

� Cheap Stock

� Post-IPO stock sales� Market standoff

� Rule 144 compliance

� Preparing for Reporting and Compliance� Section 16 – Corporate Insiders, Named Executive Officers & Beneficial

Ownership, initial Form 3

� Section 10(b) – Insider Trading

� Periodic reporting under Regulation S-K

� Dodd-Frank Act and JOBS Act limitations for newly public companies


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� Equity Types

� Equity Compensation Practices

� Communication and Education

� On the Way to An Initial Public Offering?

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� Bias in Silicon Valley toward Stock Options

� Stock Options� Reward Growth and Rising Valuations

� Preferential Tax Treatment – ISO

� Restricted Stock� Promote Employee Retention

� Taxed at Vest – no easy means to sell shares


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"Source: Radford, an Aon Hewitt company (www.radford.com)."

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� Section 422 Option Plan Requirements• Must be written

• Must be adopted by the Board of Directors

• Must be approved by the shareholders within 12 months before or

after board approval

• Must state the number of shares available to be granted

• Identifies eligible award recipients, i.e., specific employees or class

of employees because ISOs are only issuable to employees.


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� Section 422(b) Incentive Stock Option• Option granted pursuant to a plan.

• Option is granted within 10 years from the date such plan is

adopted.

• Option is not exercisable after the expiration of 10 years from the

date of grant

• Option price is not less than fair market value of the stock at the

time of grant

• Option is not transferrable

• Option not granted to individual who holds more than 10 percent of

the total combined voting power of all classes of stock

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� Section 422(d) $100,000 per year limitation

• To the extent that the aggregate fair market value of stock with

respect to which incentive stock options are exercisable for the 1st

time by any individual during any calendar year exceeds $100,000,

such options shall be treated as options which are not incentive

stock options.


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� In-House vs. Outsource• Transitioning away from Excel

� Domestic vs. International• NSO Taxation

• Mobile Employees

�

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� Timing of Communication� At Hire

� At Annual Review

� At Exit

� Communication/Education Channels� Intranet

� Webinars/Lunch and Learn

� Videos

� When to Re-Evaluate

� HR and Grant Guidelines


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"Source: Radford, an Aon Hewitt company (www.radford.com)."

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� Accounting Standards Codification

� Fair Value vs. Fair Market Value

� Estimating Fair Value

� Employee Awards – ASC 718

� Non-employee Awards –

ASC 505-50


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� Financial Accounting Standards Board (FASB) sets the

accounting rules for US corporations

� ASC 718, formerly known as FAS 123(R), governs the

accounting treatment for equity-based compensation

for employees

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� Fair Value is a calculated expense reached by applying

an option pricing model.

� Fair Market Value is equal to the current trading price*

of the underlying stock.

� (*For private companies, as established by the Board

often using a professional valuation firm.)


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� Valuation models are used to estimate the fair value

for option grants under ASC 718

� Valuation models take into consideration these factors:

◦ � Fair Market Value (FMV)

◦ � Option Price (Exercise Price)

◦ � Expected Term

◦ � Expected Volatility

◦ � Risk Free Interest Rate

◦ � Expected Dividend Yield

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� Employee: An individual who performs services for an employer, subject to the control of the employer, as to the type of work and manner of performance

� Non-employee directors are generally treated as employees for accounting purposes* but not for tax purposes


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� Requires the calculation of the fair value of each award

using an option-pricing model.

� The fair value of each award is calculated at the time of

the grant and the expense for the award is recognized

over the service period of the award (usually the

vesting term).

� This fair value generally does NOT change over the

expensing period, even if the assumptions used turn

out to be incorrect.

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� Governed by ASC Subtopic 505-50

• Requires the calculation of an estimated expense

using an option-pricing model.

• Requires expense recognition based on variable

accounting methods – adjusting the expense every

reporting period until the award vests.


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� Compensation expense is amortized over the service

period of the grant

• Generally the period between Grant Date and the

end of the vesting cycle

• The service period may end before the last vesting

date if the employee becomes eligible for retirement

and loses their risk of forfeiture on that date

(“Retirement Eligibility”)

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� Expense amortization methods:

• Straight line = expense spread in equal increments

• Accelerated (FIN28 accrual) = treats each vesting

tranche as its own grant, effectively front loading

expense in the first reporting period


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� Expense for unvested forfeited shares may be reversed

• Expense for vested shares may not be reversed

� Look at historical forfeitures to estimate forfeiture rate

• Watch out for anomalies such as RIFs, repricings, etc.

� Estimate forfeiture rate first and adjust later for actual

forfeitures

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� Tax Regulations

• IRC Section 409A

• IRC Section 83

� Award Taxation & Withholding


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� IRC Section 409A – Deferred Compensation

• Exercise price is less than the fair market value on

the grant date

• IRS traditionally defers to the public market or the

good-faith valuation of the private company’s board

of directors

• Private companies must either follow one of three

specific safe harbor valuation methods or

demonstrate that the valuation method actually used

was reasonable

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� IRC Section 409A – Deferred Compensation

• Some equity compensation may become subject to

Section 409A under certain circumstances

� Option modification

� Extension of period to exercise

� Option renewals/reloads


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� IRC Section 83

• Allows for a recipient to accelerate the time at which

the gain between the exercise price and the fair

market value will be realized

� Early exercise of ISO or NSO

� Restricted Stock Award

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� The 83(b) Election

• Election must be filed with the IRS within 30 days of

exercise/purchase

• Taxes due on spread for all shares and must be paid

immediately

• Caution! IRS does not give refunds.


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� Benefits of 83(b) Election

• Making the election reduces the amount of

compensation income reported and the amount of

taxes paid

• Decision to file should be a definite “Yes” whenever

the value on exercise/purchase date is equal to the

option/award price

• Starts the IRS holding period

• Dividend payments are eligible to be treated as

dividend income

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� ISOs

� NSOs

� Restricted Stock Awards


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� ISOs

• Tax upon sale of exercised shares

� Disqualifying Disposition vs. Qualifying Disposition

� Holding period: Two years from grant date plus one year from

exercise date

� Possible AMT liability if shares are not sold in the year of

exercise

� Ordinary Income vs. Capital Gain

� Ordinary income: difference between exercise date FMV and

exercise price

� Capital Gain: difference between sale price and exercise date

FMV

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� ISOs – Disqualifying Disposition

Option PriceOption PriceOption PriceOption Price FMV at ExerciseFMV at ExerciseFMV at ExerciseFMV at Exercise Sale PriceSale PriceSale PriceSale Price

$5.00 $10.00 $15.00

Ordinary Income Capital Gain

Short-term or Long-term*

* A disqualifying disposition may receive long-term capital gain treatment if the shares were held at least one year after exercise date.


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� ISOs – Disqualifying Disposition


$5.00 $10.00 $7.50

Ordinary Income

When the Sale Price is lower than the fair market value on exercise date, then the disposition is taxed as all ordinary income between the Option Price and the Sale Price.

If the Sale Price is lower than the Option Price, then the difference will be treated as Short-term Capital Loss.

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� ISOs – Qualifying Disposition


$5.00 $10.00 $15.00

Long-term Capital Gain

If the holding period is met, the difference between the Option Price and the Sale Price is treated as Long-term Capital Gain

If the Sale Price is lower than the Option Price, then the difference will be treated as a Long-term Capital Loss


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� NSOs

◦ Tax upon exercise of shares

� Ordinary Income vs. Capital Gain

� Ordinary income: difference between exercise

date FMV and exercise price

� Capital Gain: difference between sale price and

exercise date FMV

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� NSOs – Tax Events


$5.00 $10.00 $15.00

Ordinary Income

Due on exercise date

Capital Gain

Short-term or Long-term*

Due upon sale

*Long-term Capital Gain treatment if the shares

were held at least one year after exercise date.


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� Restricted Stock Awards

• Taxes due on vest date of shares

• Unless an 83(b) election is made

• Ordinary income: difference between purchase price

and fair market value on vest date

� Restricted Stock Units

• Taxes due on vest date

• No 83(b) election because shares are not received

until vest

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� Learn how to read your company’s charter documents (certificate or articles of incorporation, restated articles, amended articles, etc.) to understand your capitalization structure.

� Learn how to read board minutes and consents and ask your GC to give you those for entering awards in your system.

� Learn how to run a Rule 701 Test on your administration software and understand how Rule 701 operates (see Appendix – Governance slide on Rule 701 Testing)


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� Document early and often – especially for events like

severance/accelerations.

� Organize hard-copy documents and ensure

completeness.

� Ensure hard-copy agreements and exercise notices are

signed.

� Memorialize process and procedures.

� Stay current with equity changes/trends.

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� Remember that non-employee directors awards are

treated as employee awards for accounting purposes

� Be sure to review your most recent 409A valuation to

gather key details that impact your Black-Scholes

inputs

� Remember that expense may only be reversed on

unvested forfeited shares


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� Be mindful of how modifications to option awards may

result in the option award being subject to 409A

� Remember that 83(b) elections must be filed with the

IRS within 30 days of early exercise or purchase

� Remember the different timing events for tax purposes

on ISOs, NSOs, and Restricted Stock

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� Certified Equity Professionals Institute http://www.scu.edu/business/cepi/

� National Association of Stock Plan Professionals http://www.naspp.com/home/

� National Center for Employee Ownership http://www.nceo.org/

� Global Equity Organization http://www.globalequity.org/geo/

� Equity Compensation Experts grouphttp://www.equitycompensationexperts/groupsite.com/

� Compensation Café blog http://www.compensationcafe.com/


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Questions?

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Jeannette Wheeler, CEP

Solium

949-373-4762

[email protected]

Achaessa James, CEP

Stock & Option Solutions, Inc.

323-606-8060

[email protected]

Carolyn Fox

Visa, Inc.

[email protected]


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� Composition of Compensation Committee• “Nonemployee director “(Exchange Act Rule 16b-3)

� Is not currently an officer or otherwise employed by the company/parent/subsidiary (“the company”)

� Does not receive compensation from the company except as a director

� Does not have an interest in any transaction or business relationship which must be disclosed under Reg S-K “related-person transaction” rules

• “Outside director” (IRC Section 162(m))

� Is not a current employee of the company

� Is not a former employee of the company receiving compensation for prior services during taxable year

� Has never been an officer of the company

� Only receives current remuneration as a director

Reference: Selected Issues in Equity Compensation

section 4.2.1, Composition of Plan Admin Committee


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Reference: Selected Issues in Equity Compensation,

section 4.2.1, Composition of Plan Administration Committee;

Securities Sources for Equity Compensation, NYSE Rules, 303A.02

� “Independent director” NYSE• Affirmative determination by board of directors that individual

director has no “material relationship” with the company and, in last 3 years has not:

• Been an employee of the company

• Had an immediate family member (“IFM”) that has been an executive officer of the company

• Received or had an IFM that received more than $100k/year direct compensation from the company (except director and committee fees, and pension or other deferred compensation for prior services)

• Been affiliated with/employed by/or had an IFM affiliated with/employed by the company’s auditor

…continued next slide

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� “Independent director “ NYSE (continued)• Not been employed or had an IFM who was employed as an

executive officer of another company where any of the current company’s present executives served on the other company’s compensation committee

• Not been an executive officer or an employee or had an IFM who was an executive officer of a company that had financial transactions with the current company during any single fiscal year in excess of $1 million or 2% of the other company’s consolidated gross revenues

• Dodd-Frank compliance proposals� Review the source of director compensation� Review affiliation with company/subsidiaries/affiliates


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� “Independent director “ NASDAQ• Similar requirements to NYSE

• Dodd-Frank compliance proposals

� Listed companies appoint standing independent compensation committees

� Each compensation committee member meets general standards for director independence

� Committee members do not receive any kind of compensation from the company, with exceptions

� Board must consider whether committee member is affiliated with the company or any subsidiary or affiliate, and whether the affiliation would impair the director’s judgment in serving on the committee

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� ‘33 Act, Rule 701, exemption to registration – covers sales

of stock by issuing company to natural persons only

• Dollar cap test – Does value of Rule 701 securities issued in last 12

months (or last fiscal year) exceed $1 million?

• Assets test – Does value of Rule 701 securities issued in last 12

months (or last fiscal year) exceed 15% of the company’s total assets

at the end of last fiscal year?

• Outstanding stock test - Does the number of Rule 701 securities

issued in last 12 months (or last fiscal year) exceed 15% of all

outstanding same class stock at end of last fiscal year?

Reference: The Stock Options Book section 8.3.3, Exhibit 8-1


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� ‘33 Act, Regulation D, Rule 506 – Exemption for Limited Offerings & Sales without Regard to Dollar Amount of Offering

� Purchaser limit• Maximum of 35 sophisticated, nonaccredited investors• Unlimited number of accredited investors (Rule 501(e)(1)(iv)

specifically excludes counting accredited investors against purchaser limit)

• Corporations created solely to purchase shares under offering, if not accredited, each shareholder of the corporation shall count as a purchaser unless s/he is an accredited investor

� Purchaser disclosures required when nonaccreditedinvestors are allowed to participate (also true for Rule 505 exemption)

Reference: Selected Issues In Equity Compensation, section 2.5.1

and Securities Sources for Equity Compensation, Regulation D

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� ‘34 Act, Section 16 and the JOBS Act of 2012, definition of “Public Company” – When private companies become subject to public company reporting requirements even if stock is not traded OTC or listed on a national securities exchange

� Assets limit – more than $10 million in assets AND

� Shareholder limits• 2,000 or more shareholders OR

• 500 or more shareholders who are nonaccredited investors

• NOT INCLUDING employees who received unregistered equity securities through an employee compensation plan

Reference: Selected Issues In Equity Compensation, section 2.1.2


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� Recommended reading for IPO preparation:

� Selected Issues in Equity Compensation* � Chapter 3 – Preparing for an Initial Public Offering

� Section 1.6 – Sarbanes-Oxley Act of 2002 Section 404 Documenting and Evaluating Controls over Financial Reporting

� Section 2.2 – Reporting Requirements Under Section 16(a) of the 1934 Act

� Section 2.3 – Six-Month “Short-Swing” Profit Recapture Under Section 16(b) of the 1934 Act

� Section 2.5 – Resales by Plan Participants

� Securities Sources for Equity Compensation*� Regulation S-K, Item 402

*Published by the National Center for Employee

Ownership, www.nceo.org

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� Common Definitions

• Stock Option. A contractual right to purchase shares in a company for a fixed term at a fixed price.

• Stock Grant. A full value award which gives the recipient the benefit of the underlying stock value from the date of grant, plus the appreciation, if any, thereafter.

• Vesting. The process of earning shares of stock or the right to purchase shares of stock over the term of an instrument (e.g. restricted stock, stock option); the process by which shares first become transferable or not subject to a substantial risk of forfeiture by satisfying continuing service- or performance-based conditions

• Exercise. Purchase of stock pursuant to an award.• Term/Expiration. The time period during which an award is

outstanding, after which the right granted under the award expires.


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� Equity Types & Conditions• Award Types

� ISOs – Tax qualified stock options

� NSOs – Non-tax qualified stock options

� RSAs – Restricted Stock Awards

� RSPAs – Restricted Stock Purchase Awards

� RSUs – Restricted Stock Units

� SARs – Stock Appreciation Rights

• Award Conditions

� Performance Awards

� Negotiated Awards

� Transferable Awards

� Phantom Awards

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� Straight Line Expense Method

• 1,000 shares, vests 25% annually, and total expense

of $5,000

Yr 1 Yr 2 Yr 3 Yr 4

$1,250 $1,250 $1,250 $1,250


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Accelerated Method

Yr 1 Yr 2 Yr 3 Yr 4

$1,250

$1,250 = $625/yr

$1,250 = $416.67/yr

$1,250 = $312.50/yr

Yr 1 = $1,250 + $625 + $416.67 + $312.50 = $2,604.17

Yr 2 = $625 + $416.67 + $312.50 = 1,354.17

Yr 3 = $416.67 + $312.50 = $729.17

Yr 4 = $312.50

Workshop 1B The Cliff Notes Guide to Equity Comp...Learn how to read your company’s charter...

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Transcript of Workshop 1B The Cliff Notes Guide to Equity Comp...Learn how to read your company’s charter...