Let's take a break from worrying about the global pandemic to check on the health of your equity incentive plan. While we recommend that clients conduct a checkup every year, it is even more important when the economy is less stable.
The following outlines some of the best practices in reviewing equity incentive plans maintained by privately held companies. Publicly traded companies should engage in the same exercise, but are advised to consider slightly different issues in light of the impact of Institutional Shareholder Services (ISS) and/or Glass Lewis, securities regulations, and listing requirements.
- Review the Share Reserve – Review your
share reserve to confirm that the plan has a sufficient number of
shares remaining for future awards. Some companies may know exactly
how many shares they will need for the upcoming year. Others may
prefer to rely on metrics like burn rate (generally, the rate of
share usage) over the past three years to help project future
usage. If the company anticipates a need to replenish the equity
plan reserve, then review plan documents and governing law to
determine what is required for board of directors and/or
shareholder approval.
- Check the Expiration Date. New awards may
not be granted under an expired plan, so confirm whether the plan
has an expiration date. If the plan is expired, the term will have
to be extended or a new plan should be adopted. The best approach
depends on the types of awards to be issued and corporate
governance requirements (and sensitivities).
- Repricing? Some companies are realizing
that options granted in early years may be "underwater"
– i.e., the exercise price is greater than the current fair
market value of the underlying stock. In that case, there may
be a desire to reprice the awards because underwater options do not
provide the intended incentives to executives. Be sure to review
plan documents to determine whether repricing is permitted in this
situation and whether shareholder approval is required. Also,
consult your advisors to be sure that the repricing does not
interfere with ISO treatment or violate Section 409A of the
Internal Revenue Code.
- Review Performance Metrics. If vesting
of any outstanding awards is contingent on the attainment of
certain performance metrics, review the metrics to determine if
they are still reasonable and sufficiently motivating to
executives. If the recent economic slowdown significantly impacted
an executive's ability to hit certain targets, then the award
will no longer provide the desired incentives. As with
repricing, be sure to review plan documents to determine whether
(and how) performance metrics can be modified.
- Governance. Double-check plan/corporate
governance and documentation requirements. For example:
- Review the plan document and award agreement to determine what needs to be approved by the board of directors and/or shareholders and check corporate records to confirm that such approvals have been sufficiently documented.
- Confirm receipt of fully executed award agreements and, if required, shareholders agreements for all outstanding awards.
Review delegation provisions in the plan document to confirm that the document is consistent with your company's practice. Has the Board of Directors delegated authority to a committee or individual? If so, was that delegation lawful under corporate law?
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.