S R E D S A R E E L D S A X R E A E L D T S Future Tax Leaders Presentation – Executive Compensation Future Tax Leaders Presentation Executive Compensation A X R E E A E R L D T S U A X R T E E A E U R L D T F U A X T E E A U R November 27, 2017 L T F U X T E A U R T F U T E U R F U T U F
S R E D S A R E E L D S A X R E A E Topics to be Covered L D T S A • Non-Qualified Stock Options (“NSO”) X R E • Incentive Stock Options (“ISO”) E A E R • Restricted Stock Restricted Stock L D • Restricted Stock Units (“RSU”) T S U • Phantom Stock A X R T • Stock Appreciation Rights (“SAR”) • Stock Appreciation Rights ( SAR ) E E • Profits Interests A E U R • Deferred Compensation Plans (incl. 409A) L D T F U • Change in Control and Severance (incl. 280G) A X T E • THEMES: E A U • Behavior: Risk-on vs. Risk-off; Short-term vs. Long-term B h i R Ri k Ri k ff Sh L • Currency: Stock or Cash L T F U • Tax Treatment: Ordinary Income vs. Capital Gains X T E A U | 1 | R T F U T E U R F U T U F
S R E D S A R E E L D S A X R E A E Stock Options L D T S A General Overview X R E • Stock options were the most popular equity award during the 1990’s tech boom. E A E R • Since then its usage has been tempered by the requirement to expense them Since then, its usage has been tempered by the requirement to expense them under accounting rules and an overall reduction in risk appetite for employee L D T incentives. S U • Most popular amongst start-up and technology companies – no cash commitment A X R T and no realization of awards unless the company has increased in value. and no realization of awards unless the company has increased in value E E • HIGH RISK/HIGH REWARD A E U R L D T F U A X T E E A U R L T F U X T E A U | 2 | R T F U T E U R F U T U F
S R E D S A R E E L D S A X R E A E Stock Options L D T S A Definition/Risks X R E • A stock option is a right (not obligation) to purchase a fixed number of company E A shares (“option shares”) at a fixed price (“exercise price”) within a fixed period of E R ti time (“exercise period”), typically following the satisfaction of certain time-based or (“ i i d”) t i ll f ll i th ti f ti f t i ti b d L performance-based conditions (“vesting”). D T S U • Participant generally has control over: A X R • The timing of exercise (although the company can place restrictions on the g ( g p y p T E timing of exercise); and E A E • Subsequent disposition of such shares, thus maximizing the ability for the U R employee to boost his or her profit with respect to such award. L D T F U • However with potential high return comes high risk • However, with potential high return comes high risk. • Options generally have no value if the share price does not exceed the A X exercise price. T E • The timing of exercise is critical since the ordinary income tax liability can E A U significantl erode the a ard al e (i e significantly erode the award value (i.e., exercise is made when the share e ercise is made hen the share R price is high but the shares later experience a significant decrease in value). L T F U • Exercise price must be at FMV at the time of grant or else option is subject to IRC §409A. X • Participant cannot control option exercise dates – must be predetermined at T E grant. A U | 3 | R T F U T E U R F U T U F
S R E D S A R E E L D S A X R E A E Stock Options L D T S A Key Components X R E • Option Shares: To be determined by the company – typically taken from an option E A “pool” of a percentage of company capitalization (e.g., 10%). E R • Exercise Price: Under IRC 409A rules, the exercise price must be at fair market L D T value at the date of grant (or else the option is subject to 409A) and must reflect S U the most liquid stock of the company (e.g., typically common shares). A X R T • Exercise Period: Typically 10 years but the company has the opportunity at grant • Exercise Period: Typically 10 years, but the company has the opportunity, at grant E date, to lengthen or shorten the time period. E A E U R • Vesting: Either time-based on employment (e.g., three-year or five-year vest) or performance-based (e.g., upon company EBITDA at or above $10,000,000). Cliff L D T F U (100% vested at one specific time) vs. graded (partial vesting each year). (100% vested at one specific time) vs graded (partial vesting each year) A X T E E A U R L T F U X T E A U | 4 | R T F U T E U R F U T U F
S R E D S A R E E L D S A X R E A E Differences between NSO and ISO L D T S A X NSO ISO R E Income Tax Treatment Ordinary (exercise) Capital gain (stock sale) Capital gain on E A E R subsequent disposition subsequent disposition L D T FICA taxes Yes (exercise) None S U Alternative Minimum Tax Not an issue An issue A X R T E Company Tax Consideration Deduction (exercise) Not a deduction E A E U R Subject to 409A Yes (if not FMV price) No (must be FMV price) L D Qualifying Recipients T Employees, directors Employees only F U and other service providers A X T E ** ISOs have specific requirements in order to qualify as such: shares must be held for at least two E A years following the grant date and at least one year following exercise date exercise price must be years following the grant date and at least one year following exercise date, exercise price must be U R at FMV. Failure to adhere to these requirements will result in a disqualifying disposition, whereupon L the ISO will be categorized as a NSO. T F U X T E A U | 5 | R T F U T E U R F U T U F
S R E D S A R E E L D S A X R E A E Restricted Stock L D T S A General Overview X R E • Most popular award for public companies. E A E R • Not as popular with private companies because of shareholder rights Not as popular with private companies because of shareholder rights. L D • Has gained in popularity as appetite for options has faded. T S U • More prevalent with steady, lower-beta type companies (e.g. manufacturing, A construction, healthcare). ) X R T E • LOW RISK/STEADY EDDIE AWARD E A E U R L D T F U A X T E E A U R L T F U X T E A U | 6 | R T F U T E U R F U T U F
S R E D S A R E E L D S A X R E A E Restricted Stock L D T S A Definition X R E • Restricted stock is an award of actual shares of company stock that is subject to E A forfeiture pursuant to a predetermined vesting schedule. E R • Vesting can be time based on employment (e.g., three-year) or performance based L D T (e.g., upon EBITDA target). S U • Because the award consists of actual shares, restricted stock is entitled to voting A X R T and dividend rights vis a vis the class of stock subject to the award as well as any and dividend rights vis a vis the class of stock subject to the award as well as any E information rights of a shareholder (especially in a private company). E A E U R • Restricted stock awards are generally taxed as ordinary income on the date they vest and are taxed as capital gains when ultimately sold. L D T F U • Exception is so-called Section 83(b) election. A X T E E A U R L T F U X T E A U | 7 | R T F U T E U R F U T U F
S R E D S A R E E L D S A X R E A E Restricted Stock L D T S A 83(b) Election X R E • Restricted stock awards are eligible for 83(b) election where the participant E A recognizes ordinary income of the stock value as of the grant date (as opposed to E R i income recognition at vesting – presumably a lower basis if the company iti t ti bl l b i if th L appreciates during the vesting period). D T S U • However, (i) 83(b) must be made within 30 days of grant and (ii) if the shares are A later forfeited (e.g., termination before vesting), no tax deduction is allowable for X R T E the loss in respect of the forfeited shares. f f f E A E • Risks to the employee on 83(b) election are (i) stock depreciation and (ii) forfeiture U R of shares pre-vesting. L D T F U A X T E E A U R L T F U X T E A U | 8 | R T F U T E U R F U T U F
S R E D S A R E E L D S A X R E A E Restricted Stock L D T S A Restricted Stock X R E Income Tax Treatment Ordinary income E *at grant (yes 83(b) election) A E R **at vesting (no 83(b) election) at vesting (no 83(b) election) L D T S U Capital gains on subsequent disposition A X R T E E Employment Taxes Follow income tax rules A E U R L D T F U Alternative Minimum Tax Not an issue A X T E Company Taxation Deduction (at recognition of E A U R ordinary income) di i ) L T F U X T E A U | 9 | R T F U T E U R F U T U F
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