Key Issues in M&A for In-House Counsel

Employee Incentive and Retention

Strategies in M&A

Cisco Palao-Ricketts, Partner, DLA Piper – Silicon Valley

Brian Wheeler, Partner, DLA Piper – Silicon Valley

Sean Butler, Director, Legal Services, Cisco Systems

Paul Carlson, Deputy General Counsel, Seagate Technology

John Cleveland, VP Human Resources, Compensation and Benefits, M&A, Seagate

Technology

Robert Zech, Vice President and Associate General Counsel, Expedia

*This presentation is offered for informational purposes only, and the content should not be construed as legal advice on any matter.

Introduction

Brief overview of the panelists

Brian Wheeler – M&A and corporate attorney

Cisco Palao-Ricketts – Executive compensation and

employee benefits attorney

Sean Butler – In-house counsel at Cisco Systems

Paul Carlson – In-house counsel at Seagate Technology

John Cleveland – Vice President, Human Resources,

Seagate Technology

Robert Zech – In-house counsel at Expedia

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Introduction

A few high-level points to get us started…

Global M&A activity is expected to remain high following a

record year in 2015

Increased M&A activity often translates into heightened

competition for attractive assets and employee talent

Retaining employee talent often is a top priority in M&A, since

talent continuity can have a direct impact on the overall

success of a deal

Primary challenges to retaining employee talent

Perceived impact of the M&A transaction on job security

A new employer often reminds employees of career

prospects and to dust off and polish their résumé

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Introduction

Our focus today…

How target companies can structure themselves to be

attractive to potential buyers and to retain key people when an

M&A transaction is coming

How sellers structure transactions to provide for sufficient post-

closing incentives for management and key employees

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Introduction

The value of the impacted employees often drives the use of

retention and incentive pay in M&A

Why? It’s more efficient to keep key talent than it is to find,

hire and integrate new talent

The size of the deal doesn’t usually matter…

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Introduction

An incentive or retention strategy will vary, especially based on

the type of deal, the deal objective and the impact of the deal on

key talent

Merger of companies with overlapping capabilities?

Acquisition of a competitor?

Buyer focus could be on redundancies; focus may be on

customers, maybe not on employees

Seller may have a bigger inclination to try and protect its

people

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Introduction

Acquisition of a startup?

Buyer concern may focus on retention of entrepreneur

types

Divestiture?

Seller focus may be on keeping personnel through the

closing

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Questions to ask: are you a buyer or a seller?

Questions that buyers and sellers in M&A ask themselves:

Is there a need to adopt an incentive or retention program?

The answer often is “yes” if employees can have a high

impact on the success of the deal

Who should participate?

Buyers most frequently turn to the target’s senior leaders,

division leaders and certain job classifications to identify

employees appropriate for retention

Buyers should consider collaborating with target in

identifying key players

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What should be the timing and structure?

How much should the program cost?

What is the culture of target so we can foster an

environment in keeping with our strategic intent?

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Questions that buyers and sellers in M&A ask themselves…

(cont.)

How can we incentivize senior management if they just made

a significant amount of money?

How can we incentivize employees if the options and/or other

equity awards they had get accelerated and cashed out?

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Key initial steps

What type of transaction is it or could it be? Merger, stock

purchase, asset purchase?

Stock and merger deals result in a buyer stepping into the

shoes of target and assuming liabilities by operation of law

But often still requires retention packages because of

change of control provisions

What is the business objective for doing the deal?

Who are the key people we need to retain? Senior

management? The technical team?

What is our leverage or bargaining position?

Leverage has a high impact on whether a target will adopt

an incentive or retention program prior to close or whether a

seller will put something in place

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Key organizational steps

Identify the people and team/teams you’ll be working with

The M&A team, HR team and business development team

usually work together

Identify delegated responsibilities

Signing checklists

Key employees are often asked to sign agreements early

But employment discussions should not precede

agreement on price

Closing checklists

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Key organizational steps

You will want to maximize efficiency with the team you are

working with

Your work will invariably overlap with others so the better you

are at integration, the more efficient you’ll become

How do seller’s employees fit into buyer’s organization and

compensation structures?

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Typical key documents

The “term sheet” or letter of intent (LOI)

This sets forth the basic terms of the deal

Usually the business development team, certain executives

and legal counsel will be involved in putting the LOI together

Key employee issues often are addressed in the LOI

The definitive agreement (DA)

The key employment agreements

Buyer offer letter or employment agreement

Restrictive covenant agreement

The 280G analysis

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Things to think about before the LOI

On the sell side…

Are you actively thinking about who is key to your

organization?

Are the execs and key management focused on the pay and

benefits they may receive if a merger/change in control

occurs?

Are you actively thinking about their change-of-control pay and

benefits? If so, when?

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Things to think about before the LOI

On the buy side…

Buyer need to ask themselves: is employee talent a focus for

your business development team?

If so, are you actively looking at plans and agreements before

spinning a term sheet?

Look at public filings for public company target

Ask private company for equity plans and management

agreements so you can cost out the bid

Can we sense who is key/important at this stage?

Business development people

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Brief Q&A session

Any questions?

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Seller incentive and retention strategies

Long before an M&A is in the works, sellers should be focused

on the terms/conditions that apply to equity awards in an M&A

Employees don’t like giving the company flexibility to choose

treatment later

Investors and large shareholders dislike added dilution,

especially windfalls, and generally prefer flexibility

Buyers tend to favor flexible terms/conditions

Contract law concerns if the parties in the M&A decide on a

treatment that’s not specifically set forth in the equity plan

Flexibility gives HR the ability to use target’s equity for post-

closing retention goals

There is no right answer

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What does/do the equity plan(s) say about treatment of

outstanding awards in an M&A event?

Treatment should be set forth in the equity plan

The most common approaches:

The board or the plan administrator can decide at their full

discretion

The board or the plan administrator can choose from a list of

pre-set alternatives

The seller can assume; but, if not assumed, full acceleration

with advanced notice

The seller can assume; but, if not assumed, termination of

unvested awards with advanced notice

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5 key topics for discussion:

1. Is adopting a transaction bonus plan worthy of

consideration?

2. What “single trigger” or “double trigger” severance

arrangements are outstanding?

3. Is adopting a severance plan a good idea?

4. Should we grant stock options or stock appreciation rights

when a change of control is in the offing?

5. Is adopting a retention bonus plan a good idea?

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1. Is adopting a transaction bonus plan worthy of

consideration?

A transaction or carve-out plan is a bonus plan that pays out if

someone performs services through the closing of the M&A,

either to:

reward employees for staying through a change of control,

or

make up for value if target stock options are “underwater”

due to high exercise prices, high dilution, or an M&A deal

that is not lucrative

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Buyers often ask:

Who is paying for this? In most deals, it’s a seller

transaction expense…

Do we have to administer it after closing?

Who bears the cost for employer-side FICA on any post-

closing payouts?

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2. What “single trigger” or “double trigger” arrangements are

outstanding? What severance arrangements are outstanding?

Terms of art:

single trigger = automatic acceleration upon an M&A

double trigger = acceleration if termination of employment in

connection with the M&A

Prior to entering into these arrangements, consider how the

buyer will view them… “Greedy” or “market” terms?

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Buyers often structure their retention goals around these

arrangements

Will anyone get really rich and become less incented to stay

post-close?

Will the buyer ask for waivers of acceleration?

Double trigger arrangements can set a floor on the level of

post-closing retention that is offered so that people get more

value if they stay?

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3. Is adopting a severance plan a good idea?

Why adopt? Common reasons include…

If employees know an M&A event is coming and the seller

feels a need to send a message of safety

A seller that senses that they hold the leverage in the M&A

deal

A seller that senses that there will be redundancies and they

want top protect their people

Buyers generally disfavor these plans, especially large buyers

who may have their own severance policies in place and do

not want to administer different plans with different

terms/conditions

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4. Should we grant stock options or stock appreciation rights

when a deal is in the offing?

For private companies, probably not once you are negotiating

the LOI

A third-party valuation is likely stale because the

assumptions upon which the valuation was made probably

don’t include the future transaction

Section 409A penalties if grant stock options or stock

appreciation rights with exercise prices below 100% of fair

market value

Buyers are looking at this stuff…

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Alternatives:

Cash bonuses

Grant at the deal price

Hold off on making promises until things settle and ask

buyer to make the grants after closing

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5. Is adopting a retention bonus plan a good idea?

Why adopt?

Often adopted because employees know an M&A event is

coming and fear losing their jobs, but the company needs to

keep employees incented

Often pay bonuses if the personnel who are covered stay

through a certain date

Key questions:

Should it be for everyone? Or should it be offered

strategically to personnel who are viewed as key?

The size of the stay bonus program likely will be influenced

by the total expense the company is willing to endure

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Seller and buyer incentive and retention

strategies

Seller and buyer incentive and

retention strategies

Sometimes employers create a tiered structure where key

people at the highest tier get the most retention and lesser

amounts are paid to Tier 2 and Tier 3 personnel

In order to maximize the retentive aspects, the program may

protect bonuses by providing that if personnel are

terminated for a reason other than cause, death, or

disability they still get their bonus

A retention bonus plan can be a pre-closing or post-closing

arrangement, so it can be a seller or a buyer incentive strategy

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Brief Q&A session

Any questions?

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Buyer issues

A buyer usually serves up a DA that has 6 key issues involving

employee incentives and retention

1. Treatment of equity

2. Has the target adopted any compensation plans or

arrangements that will be need to be assumed or revised

pre-closing?

3. Key employee agreements as a condition to sign? Non-

competition agreements?

4. Employee retention as a condition to closing

5. Post-closing treatment of employees

6. 280G (golden parachute) taxes

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Buyer incentive and retention strategies

1. Treatment of equity

What is the status of outstanding seller equity?

In terms of value and in terms of vested/unvested

Vested equity almost always gets cashed out

Unvested: Roll over into buyer equity?

Factors-based analysis of: what’s “in the money”… how

much is scheduled to vest… by when… by whom… by

location…

Cash out, terminate or roll over?

Buyers typically don’t want to roll over unvested equity if

it means there if there is little retention value or if the

retention is short term or not worth the administrative

hassle of converting to buyer awards

32


New trend: Rollover of unvested options to restricted

cash

Why roll over? Won’t need to grant new equity to keep

people incented

Occasionally, a buyer may have a equity policy that

conflicts with rolling over equity

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… but this all depends in part on the terms of the equity

incentive plan and award agreements:

Does the transaction meet the definition of “change in

control” in the plan document?

Does the plan require a particular treatment of awards?

Does the plan permit a choice between permissible

methods?

Will vesting automatically accelerate?

If the proposed treatment in the deal is not consistent with

the terms of the plan and agreements, there may be

contract issues absent obtaining consent

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… and should any employees have their consideration held back

and paid out over time in installments?

Sometimes key employees will have their vested stock

consideration held back and paid out over time to create

retention

Need to coordinate with tax to make sure it works under tax rules

This is almost always put into the term sheet

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2. Has the target adopted any compensation plans or

arrangements that will be need to be assumed or revised pre-

closing?

If target has leverage, there may be a clause in the DA to say

buyer will honor all arrangements

If buyer has disproportionate leverage, there may be a clause

in the DA to waive benefits, to terminate arrangements or to

shift cost to seller if the buyer assumes the arrangements

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3. Are there key employees who need to be signed up to an

employment agreement pre-signing? Or, whose form of

employment agreement will be attached as an exhibit to the

transaction agreement?

In many deals, there will be a handful of key people a buyer

may want to sign on to a new employment agreement

Often, non-revocation of key employee agreements will be a

condition to close

Especially if the deal is about talent and knowledge, the target

and buyer may engage in a meet-and-greet process to assess

who the key parties believe are key

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4. Employee retention as a condition to closing

Sometimes buyers require that a high percentage of the key

employees remain through closing as a condition to close

Sometimes buyers require that some percentage of the non-

key employees not terminate as a condition to close

Keep in mind: since closing conditions like these impact deal

certainty, such condition are usually put into the term sheet

and are sensitive subjects because they can allow third-parties

to hold the deal hostage

Should never give one employee or small group of

employees the leverage to hold up the deal

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5. Do we promise to provide a certain level of

benefits/compensation to target employees post-closing?

It is very common for targets to want to protect employees

after the deal…

Service credit

Pay cash compensation at no less than what an employee

had before the deal or substantially the same as what buyer

employees have, or the better of?

Not being treated as a new hire for employee benefit plans

These clauses are a matter of leverage and negotiation

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Keep in mind:

Buyers do not acquire companies in order to run them into

the ground; buyers don’t like having to track different sets of

rules for different employee groups

In the DA, there will be a “no third-party beneficiary clause”

so it’s difficult to enforce these promises

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Do we enter into offer letters and employee agreements with

everyone?

Offer letters from the buyer are actually more protective for the

target employees

Why? Contractual privity

Offer letters from the buyer are probably a better HR practice

Why? Latest and greatest language as opposed to less than

ideal terms/conditions from old agreements

HR departments don’t like having to re-do paperwork when

they are already busy

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If the target has complex or elaborate existing agreements that

they want to preserve, they may not like new agreements

Even if no offer letters, sellers often put in a minimum

percentage of current employees that must be retained as a

condition to close the deal

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6. Section 280G golden parachute tax issues impact retention

Apply to C corporations

Does not apply to S corps (or a company that could be an S

corp)

Does not apply to LLCs (however, be careful if part of a

larger controlled group)

If paying compensation will cause a tax deduction issue, then

buyers will structure compensation to avoid 280G issues

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Compensatory payments or benefits payable to certain

executives equal or exceed 3 times their average

compensation (Box 1 W-2 or 1099 comp from the company for

the past 5 years, or a shorter period of service)

Compensatory payments include:

value of equity vesting, full value of grants within 1 year

before the change in control, grants promised by buyer,

severance, bonuses, etc.

Excess of contingent payments over 1 times the “base

amount” is nondeductible to the company and subject to a

20% excise tax payable by the executive

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For private company sellers, the 280G shareholder vote

exemption

Private company can avoid all 280G issues by disclosing all

contingent payments to shareholders and obtaining more than

75% of disinterested shareholder approval

However, before the approval is sought, the executive must

waive any and all rights to the excess amounts; rights to the

payments is wholly subject to shareholder approval

All shareholders must receive full disclosure of the payments

even if their vote is not needed to get the more than 75%

approval

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Question & answer session

Any final questions?

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Cisco Palao-Ricketts

DLA Piper, LLP

2000 University Avenue

East Palo Alto, California 94303

650.833.2190

[email protected]

Brian Wheeler

DLA Piper, LLP

2000 University Avenue

East Palo Alto, California 94303

650.833.2180

[email protected]

www.dlapiper.com

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Key Issues in M&A for In-House Counsel