Employee Retention Strategies in M&A

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
2

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
3

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
4

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…
5

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
6

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
7

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
8

 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?
9

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?
10

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
11

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
12

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?
13

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
14

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?
15

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
16

Brief Q&A session
Any questions?
17

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
18

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
19

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?
20

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
21

 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?
22

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?
23

 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?
24

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
25

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…
26

 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
27

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
28
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
29

Brief Q&A session
 Any questions?
30

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
31

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
33

… 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
34

… 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
35

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
36

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
37

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
38

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
39

 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
40

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
41

 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
42

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
43

 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
44

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
45

Question & answer session
Any final questions?
46

Cisco Palao-Ricketts
DLA Piper, LLP
2000 University Avenue
East Palo Alto, California 94303
650.833.2190
Cisco.Palao-Ricketts@dlapiper.com
Brian Wheeler
DLA Piper, LLP
2000 University Avenue
East Palo Alto, California 94303
650.833.2180
Brian.Wheeler@dlapiper.com
www.dlapiper.com
47

Employee Retention Strategies in M&A

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