409awebinarslides

Section 409A : Section 409A Real World Recommendations from Experts in the Field


Agenda : Agenda Introductions General Scope of IRC 409A 409A Compliance & Equity Compensation Valuation Methodology Frequently Asked 409A Questions Audience Questions


Introductions : Introductions Elliot Williams (Moderator) President Mirus Capital Advisors Elliot Williams joined Mirus in 1991, has been a Partner since 1997, and has served as President of the firm since 2000. Mr. Williams has worked on more than 60 advisory engagements for clients – negotiating, structuring, valuing and closing mergers, acquisitions, and financings. An expert on the Business Services Industry, over his career Mr. Williams has managed engagements in business process outsourcing, hosting, systems integration, staff augmentation, and trade show management. He has also represented clients in other industries including software, telecommunications, packaging and specialty coatings. Mr. Williams currently serves as the President of the Association for Corporate Growth, as an advisor to the boards of several entrepreneurial companies, and as an active member of the Boston Chamber of Commerce and the Alliance of Merger and Acquisition Advisors. Mr. Williams earned a B.S. in Business Administration from Babson College and holds Series 7 and 63 NASD certifications.


Introductions : Introductions Bas van der Brugge (Finance/Valuations) Senior Associate Mirus Capital Advisors Bas van der Brugge is a Senior Associate with Mirus, where he conducts Section 409As for clients. Additionally, he has participated in over a dozen M&A engagements at Mirus. Prior to joining Mirus, Bas was an associate and member of the Corporate Finance and Strategy Practice at McKinsey & Company in Amsterdam. While at McKinsey, Bas worked with the senior management of leading European and Asian companies on market analyses, company and project valuations, and to advise and structure joint ventures and strategic alliances for acquisitions and divestitures. He has worked extensively in the software, services, telecommunications, and transportation industries. Bas graduated with a Master of Science degree in Financial Econometrics from Erasmus University in Rotterdam, the Netherlands. In addition to being a CFA charter holder, he holds Series 7 and 63 certifications from the NASD.


Introductions : Introductions Andrew Liazos (Legal) Partner McDermott Will & Emery LLP - Boston Andrew Liazos heads the Firm’s executive compensation practice in the law firm of McDermott Will & Emery LLP. Andrew is ranked as a leading executive compensation and employee benefits lawyer by Chambers USA – America’s Leading Lawyers for Business. Andrew is a faculty member of the American Law Institute-American Bar Association, a John S. Nolan Fellow of the ABA’s Section of Taxation and a frequent commenter on IRS proposed regulations and guidance. Mr. Liazos is a graduate of the University of Massachusetts and Suffolk University Law School.


Introductions : Introductions Alex Lifson (Tax & Accounting) Director Deloitte Tax LLP Alex Lifson is a Director in the Global Employment Services practice at Deloitte. Alex assists clients with numerous issues related to executive compensation and employee benefits. His practice is focused on designing and implementing equity compensation strategies, executive compensation issues in mergers and acquisitions, various retirement and incentive programs, deferred compensation arrangements and performance based compensation. Mr. Lifson holds a B.A. in Economics from Bates College, an M.B.A. from Boston University and an M.S. in Taxation from Northeastern University.


Agenda : Agenda Introductions General Scope of IRC 409A 409A Compliance and Equity Compensation Valuation Methodology Frequently Asked 409A Questions Audience Questions


What is IRC 409A? : What is IRC 409A? Congress enacted 409A as part of the American Jobs Creation Act of 2004 in response to perceived abusive compensation practices IRC 409A applies to “non-qualified deferred compensation” (NQDC) Restricting the timing of deferral elections Limiting permissible payment events Restricting changes to time and form of payments Restricting certain funding vehicles Deferred compensation results in current income and is subject to an excise tax, when it is earned or becomes vested, if the plan does not meet specific requirements


What is IRC 409A? : What is IRC 409A? Applies to employees, directors and “other service providers” Applies in addition to 451 constructive receipt rules 409A contains very specific rules governing the timing of deferrals, timing of distributions, funding methods and various other aspects of deferred compensation


How does the IRS define deferred compensation? : How does the IRS define deferred compensation? Legally binding right to compensation received in one taxable year, with actual or constructive receipt of income in another Legally binding right does not exist if Company has discretion to reduce compensation after services are performed Legally binding right does exist if: Discretion is available only on a condition Lacks substantive significance


What plans are subject to 409A? : What plans are subject to 409A? Definition is very broad and includes: Elective deferred compensation Non-elective arrangements (e.g. SERPs) 457 (f) arrangements Certain types of severance Certain plans outside the United States


What plans are subject to 409A? : What plans are subject to 409A? Example: Consultant prepares PowerPoint presentation for annual bonus Performance period for annual bonus is the calendar year Compensation Committee “approves” plan design Bonus plan document is drafted but is not formally adopted No payment date is specified for the bonus Payment is made six months after the end of the calendar year Key issue: “Legally binding right”


What are the exceptions to 409A? : What are the exceptions to 409A? Customary payroll timing Short term deferrals Certain equity compensation Non-discounted options Restricted stock Stock Appreciation Rights (SARs) Restricted property Arrangements between partners and partnerships Separation pay arrangements


Agenda : Agenda Introductions General Scope of IRC 409A 409A Compliance and Equity Compensation Valuation Methodology Frequently Asked 409A Questions Audience Questions


What are the penalties for non-compliance? : What are the penalties for non-compliance? If there is a violation, affected service providers owe: Current tax on deferrals for current year and all prior years (to the extent not subject to a substantial risk of forfeiture) Interest at underpayment rate + 1% from original deferral date Additional tax of 20% of the taxable compensation If plan is not drafted correctly, all plan participants could be “affected” and all post-2004 deferrals taxable Date to amend plans for 409A compliance will likely be extended beyond 12/31/06 Timing of service recipient’s deduction not affected Few employers providing tax gross-up payments


How does 409A affect Stock Options and SARs? : How does 409A affect Stock Options and SARs? Non-discounted options not subject to Section 409A Similar treatment now extended to all SARs private and public companies cash and stock settled arrangements Exercise price may not be less than the “value” of the “service recipient stock” on the “grant date” Tax on vesting for discounted stock options & SARS Concepts apply to LLCs and partnerships


What is the Grant Date? : What is the Grant Date? Grant date critical for measuring compliance Terms of the grant must be “irrevocably established” What about letter agreements to new hires? Compare to FASB Position under FAS 123(R) Board approval date is the grant date if: employee cannot negotiate key terms and conditions between the approval date and notification date and terms are communicated within a “reasonably short period of time” after the approval date Need for internal controls on granting practices


What is the Grant Date? : What is the Grant Date? A “modification” triggers the grant of a new stock right Does a new stock right comply with 409A on re-grant? Option repricings Exception for M&A option exchanges An extension or renewal is treated as an additional deferral feature from grant date, so 409A applies Limited exception under proposed regulations allows for extended post-termination exercise period until end of calendar year or, if later two and one-half months


What is Service Recipient Stock? : What is Service Recipient Stock? Only “service recipient stock” qualifies for exception Covered entities: 50% or more subsidiaries 20% or more joint ventures with legitimate business criteria Covers publicly traded stock or, if none, the most valuable form of common stock in the aggregate Issues under the proposed regulations: preferred stock ineligible multiple classes of common stock non-publicly traded subsidiaries


What is the Value for a Private Company? : What is the Value for a Private Company? Value determined "by the reasonable application of a reasonable valuation method" – what does that mean? Unreasonable to use a previously calculated value that fails to reflect all material information, or a calculation that is more than 12 months old Two primary safe harbors Written valuation report for illiquid stock by person with significant knowledge and experience - unavailable if: company more than 10 years old liquidity event is within 12 months after the option grant or put/call rights on stock Independent Appraisal


Agenda : Agenda Introductions General Scope of IRC 409A 409A Compliance and Equity Compensation Valuation Methodology Frequently Asked 409A Questions Audience Questions


What guidelines has the IRS given for 409A valuations? : What guidelines has the IRS given for 409A valuations? “Reasonable method, reasonably and consistently applied” the value of tangible and intangible assets of the corporation; the present value of future cash-flows of the corporation; the market value of stock or equity interests in similar corporations and other entities engaged in businesses substantially similar to those engaged by the corporation; and other relevant factors, such as control premiums or lack of marketability


How is a typical enterprise valuation different from a 409A valuation? : How is a typical enterprise valuation different from a 409A valuation? Determine Total Enterprise Values (TEV) using various methods Model capital structure (liquidation preferences, conversions, options, etc). Determine common stock valuation using allocation method Specific to 409A (and other option plan related valuations)


What does a full valuation entail? : What does a full valuation entail? Market Approach Public markets M&A transactions Private placements Asset Approach Liquidation value Income Approach Discounted cash flows (Embedded) options Scenario analysis Company Specific Prior equity events Approach Method Replacement cost Other relevant factors


What complexities arise due to the capital structure? : What complexities arise due to the capital structure? Series B Liq. Pref. Series A Liq. Pref. Options Exercised Series A Caps Series B Caps Series A Converts Series B Converts Equity value ($ MM) Proceeds ($ MM)


What are the different value allocation methods? : What are the different value allocation methods? Current Method Value common as if a liquidity event occurs today Apparently widely used, but only appropriate in limited circumstances Option Method Either Black & Scholes or binomial trees Depends on some critical inputs such as volatility and exit horizon Probability Weighted Expected Return Valuation analysis based on various exit scenarios (IPO, trade sale, liquidation) Highly dependent on a handful of assumptions


How can you account for the evolution of value? : How can you account for the evolution of value? Scenario 3 $ 0 MM Scenario 2 $ 50 MM Scenario 1 $ 150 MM Year 1 $ 40 MM 10% 40% 50%


Agenda : Agenda Introductions General Scope of IRC 409A 409A Compliance and Equity Compensation Valuation Methodology Frequently Asked 409A Questions Audience Questions


Frequently Asked Questions : Frequently Asked Questions What 409A issues arise in M&A transactions?


Frequently Asked Questions : Frequently Asked Questions How can IRC 409A impact my ability to go public?


Frequently Asked Questions : Frequently Asked Questions Can I do the section 409A valuation myself?


Frequently Asked Questions : Frequently Asked Questions How does IRC 409A relate to FAS123R?


Agenda : Agenda Introductions General Scope of IRC 409A Compliance with 409A Valuation Methodology Frequently Asked 409A Questions Audience Questions


Audience Questions : Audience Questions


Thank you : Thank you This presentation can be downloaded at http://www.merger.com/409awebinar Presenter contact information: Elliot Williams, Mirus Capital Advisors williams@merger.com; 781-418-5932 Bas van der Brugge, Mirus Capital Advisors brugge@merger.com; 781-418-5941 Alexander G. Lifson, Deloitte alifson@deloitte.com; 617-437-2546 Andrew C. Liazos, McDermott Will & Emery aliazos@mwe.com; 617-535-4038