Executive Equity Compensation in Severance Negotiations
This article was published in CEOWorld Magazine on October 30, 2019.
As a CEO, C-level or other senior executive, the most valuable part of your executive compensation package can often be the equity position that you acquire in connection with your employment. If you have a well-designed executive employment agreement in place, your equity compensation would be structured for maximum gain and tax-favored income if you and the company are successful.
But what happens to that equity position if you face employment termination?
Employment termination can occur even if you have been doing a good job and the company’s performance is strong. Termination can occur from any number of reasons. It could be from a new CEO who wants “to go in a new direction”, often a euphemism for wanting to bring in his or her own team. It could be from a downturn in the company over which you had no control. It could be that instead it is you who wants to leave the company because your success was noticed and you’ve been offered a new opportunity that you don’t want to pass up. In all these cases, you have made your contribution to the company and you do not want to leave behind that equity position you earned, your rightful share of the company’s growth that you were an important part of.
This article discusses and offers tips for severance negotiations over equity including –
- What to include in your offer letter or executive employment contract when you join the company?
- What to seek in a change-of-control / retention situation?
- What to negotiate for on employment termination?
- The importance of equity in your severance negotiations.
Negotiating Equity Severance Terms When You Join the Company
Executive equity compensation may be in the form of incentive stock options (ISOs), non-qualified stock options, restricted stock or restricted stock units (RSUs) or performance shares in a corporation, or capital or profits interests in an LLC. Several of my earlier executive employment articles discuss the merits and taxation of these alternative structures for equity and their benefits in particular business situations.
Additionally, important terms to seek in your executive job offer letter or employment agreement are also discussed in my earlier CEO World articles on those subjects.
Yet in those negotiations over the executive contract terms of your offer, there is often a temptation of focus solely on base salary, bonus and benefits and not on severance. And to the extent severance is taken up, it is done so, solely as how long the paid severance will be.
Where, as stated, equity can be the most valuable part of your executive compensation package, equity should be addressed in the severance terms of your offer letter or employment agreement. For example, if your offer letter provides 12 months’ severance pay, then seek 12 months accelerated vesting on equity.
Both the employment agreement and equity plan need to be checked that such accelerated vesting will occur for involuntary terminations without “cause” and also for voluntary terminations for “good reason”.
Negotiating Equity Severance Terms in Change-of-Control and Other Retention Situations
If your company is “in play” you may be offered a retention agreement on change of control. These agreements often contain a double-trigger acceleration term for option grants, RSUs or other equity. Typically, this trigger requires the sale of the company and the involuntary termination of the employee. It is designed to provide a safety net for employees, especially CFOs and GCs, who may be terminated during post-closing integration.
Here too you should negotiate over equity in severance. If possible, it is best to seek a single trigger. If your efforts have brought the company to a success event so that the investors are able to cash out, why should you have to wait until termination before you cash out. What if you are not terminated and want to leave for a better offer after sale of the company – your hands are tied by the double trigger.
Again, you want the change of control premium you are to receive, whether single trigger or double trigger to embrace acceleration of all of your equity. You should also seek executive claw back terms as well, under which if you are terminated before the change of control, you have the chance to get some benefit of the appreciation had you not been terminated.
For other terms to seek, including protections against application of the excise tax of IRC Section 280G on parachute payments, please refer to my earlier articles on change of control agreements and retention agreements.
Negotiating Equity Severance Terms at Employment Termination
The final opportunity to negotiate equity severance terms is in connection with employment termination. Even if there are no protections for your executive equity compensation in your offer letter and there was no retention agreement, you may still have sufficient bargaining power on severance to seek the key terms needed.
Some of the ways you may have leverage in employment separation negotiations include
- legal claims you may have against your company related to wrongful termination of employment,
- post-termination transition services and support the company may desire from you, and
- cooperation to sign a lock-up agreement or other documents or actions post-termination.
In those severance negotiations, there are a number of ways you can use your leverage to preserve and even enhance your equity compensation. Most plans, if carefully reviewed by an experienced executive employment lawyer, will be found to provide Board or management discretion sufficient to provide the terms on separation that the C-level or senior executive should be seeking.
In most cases, incentive stock options must be exercised within three months of your termination to retain the tax benefits that apply to incentive stock options. However, your severance terms can provide for an extended period of exercise, with the option losing their ISO character after 90 days, but critically you retains your option rights. For options, restricted stock units and other equity, separation terms can provide for continued vesting during a period of part time service or consulting. ISOs are more restrictive – available only for employees, but not so other equity. Alternatively, vesting on equity can be accelerated. Such changes require care in negotiation and drafting to assure compliance with the tax law, IRC Section 409A, on deferred compensation.
Other key equity terms to seek include provisions for cashless exercise of options and provisions for partial redemption of RSUs if the shares are not yet publicly traded. Planning considerations need to include not only payment of the strike price on options but also potential taxation of equity.
Importance of Equity in Each of Your Negotiations
Equity can be the most valuable part of your executive compensation because it is the dynamic part of your executive compensation package that can potentially grow exponentially. Your base salary and bonus are paid in fixed dollars. However, if you hit it right on your equity piece, it might double or triple in value or even more if the company succeeds.
Another important aspect is that equity is your pay back for the value you have created in the company. Investors get their pay back for their investment of cash. But your investment of your time, your insights, your knowledge and creativity are what made the company successful. You deserve your equity pay back for that investment as well.
At the same time, while equity compensation is a big piece in severance negotiations, there are other terms that should not be neglected, such as continued medical coverage for your family, considerations for entering into confidentiality, non-disparaging agreements and other restrictive covenants, letter of reference, etc. It is wise to retain an executive employment agreement lawyer to increase your bargaining power and get the benefits and compensation that you deserve!