The Treatment of Stock Options in the Context of a Merger or Acquisition Transaction - 30 Nov 2011

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This is a great resource covering a topic that does not get enough attention in our industry.

A principal issue in merger and acquisition transactions is whether,
and to what extent, outstanding options will survive the completion of
the transaction and whether and when the vesting of options will be
accelerated. It is critical for a properly drafted equity incentive
plan to include clear, unambiguous provisions for the treatment of
outstanding awards in connection with these types of transactions,
which include a company's consolidation with or acquisition by another
entity in a merger or consolidation, or a sale of all or substantially
all of a company's assets (hereinafter referred to as a "Corporate
Transaction").

Whether a change of control of a company should provide for accelerated
vesting is a business decision and a separate and distinct issue from
the impact the Corporate Transaction will have on the outstanding
options. Equity incentives have significant implications in the
negotiation of a Corporate Transaction, as their treatment can affect
the value of the Corporate Transaction and the consideration to be
received by stockholders.

Corporate Transactions

Assumption vs. Substitution

Cancellation

Cash Out

Acceleration of Vesting upon a Change of Controlemployed.

Single Trigger

Advantages

• Aligns the interests of option holders and stockholders by
  allowing the option holders to share in the value they have created

• Provides for equitable treatment of all employees,
  regardless of their length of employment (assuming all options are
  fully accelerated)

• Provides for a built-in retention award, allowing the
  target company to deliver an intact management team to the acquirer,
  which can eliminate the need for a cash retention arrangement through
  the date of a Corporate Transaction

• No affect on earnings as vested equity awards are treated
  as an expense of the target company

• Beneficial when acquirer is going to terminate the existing
  equity plan or will not be assuming or substituting the unvested options

Disadvantages

• Can be viewed as a windfall for option holders who will be
  terminated by the acquirer or who were recently employed by the target
  company

• No retention or motivational value after the change of
  control

• Will require the acquirer to issue its own equity
  post-transaction to newly incentivize employees of the target company

• The payment in respect of the acceleration will be taken
  from the consideration that would otherwise go to the stockholders of
  the target company

• The acquirer must deal with the fact that its acquired
  workforce has fully vested equity awards, while its pre-existing
  employees do not, which may present integration issues

• Viewed negatively by stockholders and investors, and
  specifically by governance groups, as a problematic pay practice

Double Trigger

Under a double trigger provision, the vesting of awards accelerates
only if two events occur. First, a change of control must occur.
Second, the option holder's employment must be terminated by the
acquirer without "cause" or the optionee leaves the acquirer for "good
reason" within a specified period of time following the change of
control.

Advantages

• Aligns option holder and stockholder interests more fully

• Provides a key retention tool for senior executives who are
  instrumental to the integration process

• Alleviates the need for additional retention incentives by
  the acquirer in the form of cash or additional equity

• Provides protection for the option holder in the event of
  termination of employment due to a change of control

• Viewed by corporate governance and stockholder advisory
  groups as the preferred approach to acceleration of vesting

Disadvantages

• Option holders, unlike stockholders, may not immediately
  share in any tangible increase in value of the company's stock (or the
  acquirer's stock)

• Loss of value if the unvested options are not assumed or
  substituted by the acquirer, since a double trigger is useless if
  awards are terminated at closing

• If the acceleration provides a substantial payment, it
  provides a disincentive for employees to be retained by the acquirer
  and a motivation for those who continue to be employed to be asked to
  leave the acquirer

Steps to Consider

In preparation for the negotiation of a Corporate Transaction,
companies should consider taking the following steps:

1. Review the company's existing equity incentive plans to
   determine and understand what ability (or lack of ability) the company
   has to determine the treatment of its stock options and other awards in
   connection with a Corporate Transaction, and consider whether the plan
   or agreement can be amended to fix problem grants.


2. Confirm that the company's existing equity incentive plans
   expressly and unambiguously permit without the optionee's consent the
   assumption, termination, and cash out of options, including the
   cancellation of underwater options without consideration.


3. Review any and all agreements containing change of control
   provisions to ensure that the provision governing the treatment of the
   award in a Corporate Transaction and change of control protection (if
   any) are consistent.


4. Periodically review the equity incentive plans and forms of
   agreement in light of continuing changes in the law and market
   practices in compensation arrangements and corporate transactions.

Pamela Greene, Member,
PBGreene@mintz.com

Pamela Greene is a Member in Mintz Levin's Corporate &
Securities Section. She concentrates on counseling the firm's public
company clients with respect to executive compensation-related issues;
securities compliance under both the Securities Act of 1933 and the
Securities Exchange Act of 1934; and corporate governance matters,
including compliance with the Sarbanes-Oxley Act of 2002. Pam works
with public and private company management teams, boards, and
compensation committees to develop and design appropriate executive
compensation programs, and to resolve legal issues confronting
employers when implementing and revising such programs.  Pam
also handles corporate and securities law matters for a range of
businesses, including emerging companies and private equity investors.
She represented both corporations and investors in private placements,
public offerings, mergers and acquisitions, and general corporate law
matters.  Pam is admitted to practice in Massachusetts and is
a member of the National Association of Stock Plan Professionals and
received her J.D., cum laude, from Boston University School of Law.

Pamela Greene|Member
Mintz, Levin, Cohn, Ferris,
Glovsky and Popeo, P.C
One Financial Center
Boston, MA 02111
Direct : (617) 348-1623
Fax : (617) 542-2241
E-mail : pbgreene@mintz.com

Full Bio

Ann Margaret Eames, Associate, 
AMEames@mintz.com

Ann Margaret Eames is an Associate in Mintz Levin's Corporate &
Securities Section. Her practice is focused on securities, venture
capital and general corporate law.  Ann Margaret advises
public companies in connection with public offerings, SEC reporting
compliance, listing requirements and general corporate governance
matters.  In addition, she represents both public and private
companies and investors in a range of corporate transactions, including
mergers and acquisitions, stock and asset purchases, and other finance
transactions.  Ann Margaret is admitted to practice in
Massachusetts and received her J.D., summa cum laude, from Suffolk
University Law School.

Full Bio

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Material in this work is for general educational purposes only, and
should not be construed as legal advice or legal opinion on any
specific facts or circumstances. For legal advice, please consult your
personal lawyer or other appropriate professional. Reproduced with
permission from Mintz Levin. This work reflects the law at the time of
writing June, 2011.