RESTRICTED STOCK FOR C-LEVEL HIRES

Below is an article by Robert Adelson that was first published in the April 1, 1999 issue of Genetic Engineering News, dealing with the use of restricted stock and restricted stock units, RSUs, and suggesting use of the restricted stock and RSUs signing bonus in the recruitment and hiring of C-Level and other senior executives biotechnology and life science industries. It is noted that the concepts and approaches discussed in this article have also been used successfully by Executive Employment Attorney Robert Adelson in representing executives in software, telecommunications and other technology based industries.

How to Pay More for Biotech Talent And Still Save Your Company Money

By Robert A. Adelson, J.D., L.L.M

In the volatile biotechnology, medical device and pharmaceutical industries, executive and technical talent is critical to success and difficult to maintain. Are you doing all you can to attract and retain talent for your company?

A prized hire says, “show me the money,” and you don’t have it. If you had the recruit, you could grow and make the money. Is there a way out of the box?

Key executives and technical people leave when you can’t keep pace with industry pay levels. How do you keep the team in place and motivated? Can you cut pay-driven turnover?

This article offers techniques for incentives and pay raises to beat the competition, build your company, not break the bank and even save money. These techniques deliver big-time dollar value to the employee; a lower tax cost than normal bonus pay; greater perceived value to employee; no net cash cost to the company; and actual cash savings.

Use a Signing Bonus

Technical and executive hires often resist switching jobs because of vesting benefits, expected bonuses and other “golden handcuffs.” A signing bonus can be your golden key to unlock the door to hiring.

In 1996, Alex Mandl left his job as COO of AT&T to become CEO of early-stage communications carrier Teligent with a $25 million signing bonus to compensate Mandl for what he lost by leaving AT&T.

When cash like that is out of the question, your golden key can be fashioned in the creative use of company equity to serve the same purpose. An equity based signing bonus can equally cement the bond with your company and compensate a new hire for risks taken in leaving a job.

What you pay up front can vary, depending on your need and the immediate value the person brings, as well as what the person gives up to join you. An equity-based bonus can take many forms: qualified or non-qualified stock options, restricted stock or phantom stock.

The offer of meaningful equity-stock options or phantom stock in your firm-can set your company apart in the battle to build your team.

To enhance and “sell” your equity, the company can offer a package of rights to deliver a real equity stake to key employees. This can include anti-dilution protection of the value of employees’ equity against future corporate changes and future issues of stock to others. Cash-out protections can allow the employee an “exit strategy” to realize cash value on shares where there is no prospect of an IPO or sale of the company. Alternatively, change of control protections accelerate vesting of shares when the company is sold and the employee’s position may be at risk. Post-termination protections allow stock concessions to lessen fear of termination, as most employment is at will.

Employee equity also benefits the company. Equity for pay preserves cash. It can also make money from tax deductions. Equity helps in other ways-it rewards employees for their loyalty, their individual project achievements and the firm’s success, and it brings employees an entrepreneurial mindset. It can also backstop or serve as consideration for non-compete and confidentiality agreements that are often signed at the time equity is offered.

Tax Favored Equity Boosts Pay

To leverage the firm’s future payout to employees, you should structure equity so it’s taxed at as low a level as possible. This structuring will boost the technical and executive take-home pay.

Because pay increases are taxed at the person’s highest marginal rate, the ability to cut that tax bit and increase the tax-home pay is a powerful tool to show that the equity-based signing bonus or pay raise is more valuable to the employee. Here the rule of thumb is that stock options are better for high-value equity and restricted stock is better for low-value equity.

Founders’ Shares Attract Key People

For senior recruits, technical or executive, you want to offer more to beat the competition. For key people, non-qualified options or restricted stock can be offered in lieu of cash to deliver immediate value with a strike price much less than current fair market value.

By offering stock or options at a nominal price, the recruit has a built-in value from day one. Yet by using its stock, the company has avoided cash cost. The company will only have to pay out if a future stock buy-back is offered. Yet by that date (several years later), the company may be out of the box and in a position to pay.

Stock offers key advantages that make equity more valuable to employees than cash. Some of these benefits are:

  • Pre -IPO stock is valued at discount, and all stock is awarded without brokerage charge;
  • Stock offers the potential for considerable appreciation that cash lacks;
  • Appreciation is taxable at lower capital gains rates of 20%, with no withholding;
  • Stock offers the potential for future roll-over so that tax may be deferred indefinitely.

The tax-free roll-over, new from the 1997 Tax Law, potentially allows employees who receive C corporation stock from biotechnology companies the right to see these shares and roll over profits into new ventures, with tax deferred until the final sale of shares.

Shares and Tax Gross-Up Save Money

In addition, because the issue of founders’ shares is deductible, the company can save money that would have gone to taxes by using stock for pay. The tax windfall can also be used creatively to enhance efforts to recruit or retain key people. This is done by sharing the company’s tax windfall with employees.

This sharing, in the form of stock appreciation rights or tax gross-up, can have the effect of reducing effective tax on restricted stock from the ordinary income rate of 39.6% to the 20% of capital gains rate or even lower. This is also useful in family businesses or professional corporations that cannot offer stock or options but must use phantom stock instead.

Example of Equity Pay and Tax Savings

The table above shows an example of a biotech company, BioCo, that uses equity and the resulting tax deduction to save itself money, but still offers what appears to be a large premium to land Mr. Smith, the technical or executive hire it is recruiting. In this example, the company can only offer $100,000, but employee Smith wants $150,000. By creative use of founders’ stock and tax gross-up, the company can offer a premium package worth $170,000, but at a cash cost to the company of only $94,000.

However, tax advice needs to ensure the right mix of equity, including restricted stock, ISOs, non-qualified options, Stock Appreciation Rights or Phantom Stock. In each case, plans must be carefully structured to avoid ruinous “tax surprises.” Accounting advice is also important to balance the benefits of wealth transfer in below-market stock and options, SARs and tax-gross-up with potential hit to earnings on financial statements. Clearly, these techniques are not for everyone. Where a company is in play and its PE ratio critical, accounting concerns will govern. However, if growth is the priority, cash savings are important, and building the team is critical, these techniques merit close consideration.

Robert A. Adelson, J.D.,LLM., is a corporate and tax attorney at Engel & Schultz, LLP, Boston, MA. He can be reached at 617-875-8665 or radelson@engelschultz.com. Robert Adelson represents companies and individuals, in biotechnology, medical device and other technology-based fields across the U.S. on employment, stock, options, relocation, severance, and executive compensation issues. He also advises on consulting, trademarks, trade secrets and strategic alliance contracting and on mergers/acquisitions.