Question: I was fascinated about your bright explanation of equity plans in your newsletter entitled “Long Term Incentive Compensation: 10 Basic Concepts.” Soon my company will be disentangled from the parent corporation and we will face an IPO (shorthand for “initial public offering,” or sale of the company to the public).
I was wondering what the impact will be on my Long Term Incentive (“LTI”) schemes, since the underlying value of the stock price will cease to exist as of the separation of the parent company.
Answer: Dear Wouter: Your question is an important one, and a common one, as well. Thanks for writing in from the Netherlands, and asking it:
1. First, carefully review your Equity Plan, or have someone do so for you. The first step in your analysis of what happens to your equity is “What does the Equity Plan say, if anything, about this circumstance?” Usually what happens upon a sale of the company is covered in an Equity Plan, but not always. You might look for the phrase “Change in Control,” as a sale and an IPO are both kinds of change in control.
2. In general, you should receive the same percentage of the company’s sales price (after deduction for company debts) as the percentage of the company your equity represents. In general, if your stock represents one half of one percent (that is, 1/2 %) of the company, then you should receive one half of one percent (1/2 %) of the sale price of the company, less debt obligations, whether it is sold to a private investment group or to the public in an Initial Public Offering (“IPO”). While that may sound very small, if the sale price of the company is $100 million, 1/2 % of that is $500,000, not a small sum.
If the sales price is $100 million, and the acquirer is not taking subject to $10 million debt, then you would be entitled to 1/2% of $90 million, or $450,000. By the way, in an Initial Public Offering (“IPO”), it is common to see the company sell a fraction of its shares – perhaps 20%, perhaps 75%, but not necessarily 100% – to the public.
Of course, these statements and examples are grossly simplified, but they do provide the general framework of what you can expect to take place.
3. Exceptions, limitations or variations from this general rule, if any, should be found in your Equity “Plan.” Review carefully the details of your Equity Plan, which should provide for you any exceptions, limitations or variations. For example, if your company issued special classes of stock, such as “preferred” stock, those classes of stock may have greater rights than your stock, which is probably “common” stock, entitles you to. Some equity plans give employees a “lower level” form of equity, which values their shares a bit differently. Some equity plans even give employees a form or “phantom” equity, which is not “real” stock shares but “equivalent to” stock shares, and may be treated differently upon a sale.
4. As to any unvested equity you may have, it is common (though not universal) that it would all vest in accelerated fashion upon sale, IPO or other “change in control.” In my experience, in perhaps 75% of cases, unvested equity owned by employees immediately vests (called “accelerated vesting”) upon a sale of the company, or its assets, or some other manner of “change in control.” Again, review your Equity Plan to see if you are entitled to “accelerated vesting.”
Leaving but Want Your Options Vested? This is especially possible for those who are laid off without “cause.” We offer a Model Memo Requesting Vesting of Unvested Options When Laid Off. It shows you “What to Say and How to Say It.”™ To obtain a copy, just [ click here.] Delivered by Email – Instantly!
5. If your company is owned by a “private equity” (sometimes called “PE”) firm, you need to be extra-vigilant. I hope I don’t sound cynical, or even paranoid, but I have seen many, many instances in which employers owned by private equity companies seem to do a “bait and switch” to their employees’ detriment.
First, when the private equity company takes control of the company, the employees are often told “We are lowering your salaries, and your benefits, but you will receive great reward when the company is resold, or undergoes an Initial Public Offering.” Then, it seems, in one way or another, the promised “rewards” are far, far less than the employees were led to believe they would be. Or, sometimes employees are told that the “outside investors” are being paid “cash,” while the “employee investors” must now take stock in the new company, instead of “cash.”
In any of these (or similar) circumstances, I commonly urge all affected employees to chip in to consult with one attorney or law firm to represent their interests in what might, in the end, turn out to be a kind of fraud.
If your employer is selling to Private Equity investors, you can proactively request protections be put in place to protect you from probable changes. We offer a Model Memo to Managers Seeking Protections When Private Equity Investors Approach Ownership. “What to Say and How to Say It.”™ To obtain a copy, just [ click here.] Delivered by Email – Instantly!
6. Don’t be reticent about submitting any remaining questions to Human Resources: Don’t hesitate for a moment before submitting any remaining questions to Human Resources. If you do so, I suggest strongly that your submission be in writing, to make sure a clear record exists of your question, and their answer. Any remaining questions you may have should be addressed to Human Resources – in emails, which make a record of what you asked, of whom you asked it, and when you asked it.
Wouter, thanks for writing in. I believe you are the first person to submit a question from the Netherlands. I hope this has been helpful, and that you will tell your friends and colleagues about our blogsite. And, too, your children, because “it isn’t getting any easier out there.”
© 2011 Alan L. Sklover, All Rights Reserved.