Slide 1: Converting Stock Awards in a Merger or Acquisition July 12, 2006
Michael T. Frank DLA Piper Rudnick Gray Cary US LLP 2000 University Avenue East Palo Alto, CA 94303 (650) 833-2000 michael.frank@dlapiper.com Ellen N. Sueda Hewlett-Packard Company 3000 Hanover Street, MS 1050 Palo Alto, CA 43304 (650) 857-3984 ellen.sueda@hp.com
Slide 2: What Do the Plans Provide? Target’s Plan
• Does the Plan permit conversion of awards? • Does the Plan permit early termination of awards that will not be continued? • Are there notice or consent provisions?
Buyer’s Plan
• Does the Plan provide for substitution of awards?
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Slide 3: Should Buyer Convert Awards? • Determine the retention impact
• Part or full acceleration of vesting upon the change may impact retention planning • Buyer may not want to convert options if there is no retention value
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Slide 4: Should Buyer Convert Awards? • Consider tax impact
• The loss of qualification of ISOs with acceleration of options due to the ISO $100K limit • Section 280G: non-deductibility of certain accelerated awards and compensation
• Consider the number of former employees of Target who hold awards
• Securities held by a former employee may require additional securities filings
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Slide 5: Should Buyer Convert Awards? • Non-U.S. jurisdictions
• Determine labor/employment laws, regulatory requirements, e.g., governmental filings, and foreign exchange requirements • Determine if awardees subject to immediate taxation upon the change of control • Consider Buyer’s policies concerning awards in various jurisdictions
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Slide 6: Retention • Buyer may not want to convert awards that have no retention value, e.g., awards that have full acceleration of vesting upon a change of control
• Do not forget to review individual employment agreements or arrangements in addition to the plan and individual award agreements • Consider the following:
• Consent from key employees to amend awards to remove or modify acceleration of vesting • If a cash deal, arrange for a holdback of award proceeds for key employees (do not forget about 409A)
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Slide 7: Due Diligence A good due diligence list is important. It will remind you of the pitfalls and challenges of mergers and acquisitions!
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Slide 8: Assume or Substitute?
• Assumption Pros:
• Preserves your share reserve • Can grant assumed reserve shares, but not for employees of Buyer
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Slide 9: Assume or Substitute?
• Assumption Cons:
• Multiple share buckets in multiple deals • Awards treated as non-shareholder approved for “201(d)” table in proxy/10-K • Additional overhang • Form S-8 filing, including a prospectus • Administration of another plan’s terms and conditions in addition to already existing plans
• Who will administer the plan and update prospectus? • Different plan terms and conditions complicate any future communications • Reserves and registration need to be tracked separately
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Slide 10: Assume or Substitute?
• Substitution Pros:
• One share reserve • May be able to harmonize rules (beware ISO modification and 409A) • Report awards as shareholder approved in the proxy • No separate Form S-8 filing • No need to administer another plan’s terms and conditions; however, if material terms are preserved and are different from regular option grant terms, then should be described in the prospectus and other communications (also, watch modification)
Slide 11: Assume or Substitute?
• Substitution Cons:
• Impacts existing share reserve • Changing terms may require optionee consent and cause confusion to optionees
Slide 12: Conversion Mechanics
• Preserve Aggregate “Spread”
• Typically, when applying the conversion ratio, round price up and round share number down
• Preserve Ratio of Fair market Value to Strike Prices
• Example
Target holds an option to buy 100 shares @ $5 per share. Target shares worth $10 at closing. Buyer shares worth $20 at closing. Target option becomes buyer option to buy 50 buyer shares @$10
• Used to retain ISO status and avoid 409A problems
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Slide 13: Restricted Stock – Specific Issues
• Does Plan require explicit assumption/assignment of forfeiture or repurchase right? • Cash deal = right to get cash?
• Securities law issue of treating shareholders of the same class of stock differently
Slide 14: Employee Stock Purchase Plans
• Generally are terminated upon an acquisition • Target should expect that its ESPP will be terminated and ensure that the plan document provides for mid-period termination
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Slide 15: Additional Issues to Consider
• ISO rules • 409A compliance • Earn outs • Cash transactions • Grant documentation (accounting or 409A issues?)
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Slide 16: ISO Issues
• Is there a $100K limitation issue?
• Will acceleration of options disqualify all or part of the option?
• Will there be any modification causing a disqualification? • Conversion mechanics nearest whole cause a disqualification? E.g., rounding shares up or rounding strike price down • If substituting, does Buyer’s plan provide for applicable ISO rules?
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Slide 17: Section 409A Issues
• Discounted stock options • Option pricing history and methodology
• Reasonable valuation or safe harbor for stock valuation for private companies
• Modification of plans or stock awards after 12/31/04
• • • Extension of exercise period? Faulty conversion? Repricing?
• RSUs with retirement features and/or deferral of equity awards
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Slide 18: Earn Out Issues
• Exchange of “share right” for earnout right? • Including earn out right in option
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Slide 19: Negotiation Items
• Have Target revise non-compliant plans and arrangements, e.g., reprice or limit exercise on discounted options. Special Indemnity Escrow? • • • Cover future compliance and other “HR” costs? Consider in light of Section 409A and recent option backdating issues
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Adjust purchase price by amount necessary to gross-up taxes, e.g., 409A or 280G, and cost of withholding/reporting, or include adjustments as part of the escrow arrangement.
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Slide 20: For Questions Please Contact:
Michael T. Frank DLA Piper Rudnick Gray Cary US LLP 2000 University Avenue East Palo Alto, CA 94303 (650) 833-2000 michael.frank@dlapiper.com
