Equity Compensation, Unprecedented Times Require Unprecedented Actions
Since the rise in popularity of equity compensation during the 1980s, we have experienced only a few moments of volatility similar to that of the past four weeks. The experts at FutureSense have been there for major events like the semiconductor crash in the early 1990s, the Dotcom crash as we left the last century, the telecom crash a few years later, September 11, and the financial crash to end the last decade. Each provides valuable experience and insight into how the best companies navigate an extremely volatile market.
The most important lesson is that the companies who prepare the soonest, and act early with the most confidence, were those whose plans were the most likely to weather the storm. Those who waited were often left trying to convince increasingly disgruntled investors to support programs that provided benefits in which the shareholders could not share. The list below provides a prioritized framework that you can use to plan, execute, and grow, even in these challenging times.
Over the next week or two, we will be providing additional details on each item. If you need help immediately, or simply have a question about where to start, you can reach Dan Walter, Managing Consultant at dan@futuresense.com. We are here to help!
1) Initiate the items below as part of an “Emergency Equity Program” or a broader “Emergency Reward Program”.
a) This will be a program designed to meet the specific needs of your company as well as your employees.
b) Different employee groups can be addressed uniquely, with different direct programs or different CHOICE programs.
c) Basically, everything available or conceivable in the equity/reward toolkit must be on-the-table for consideration. Companies can target to set aside an “Emergency Reserve” of equity to provide additional room in the overhang.
2) Communication must be the foundation of any effort. These are confusing times. Equity compensation can be a confusing pay element. Provide clear, consistent messaging about the intent of each equity plan, the intent of any changes, and the impact on any employees.
a) Evaluate and communicate the consequences of doing nothing.
b) Understand and communicate the perception of doing something.
3) Review your termination provisions.
a) Determine if adjustments need to be made to support the potential furlough or layoff of employees.
b) Can you easily allow people to hold onto equity after their termination date?
c) How much would it cost to cash out some, or all, of outstanding equity at each employee level?
d) How will this impact executives if you have to reduce headcount near the top of the company?
4) Review the possibility of the "reallocation" of some of your executive compensation.
a) A historically strong market has buoyed many executive packages.
b) This may be a good time for executives to "donate" some of their equity, or its value, to a broader group of employees. Many executives have already started the process of reducing their own pay.
c) No executive makes enough to replace their entire staff's pay, but small amounts may be enough to help people through these times.
5) Perform an equity compensation triage assessment on a monthly basis.
a) Assess your outstanding awards and determine what must happen now and what should wait for a future evaluation.
b) Do not wait so long that actions no longer have an impact, or will no longer be appreciated.
6) Determine the best Stock Option or RSU correction program(s) for your needs. Option Repricing, RSU for Option Exchanges, RSU for RSU Exchanges, Cash for Equity Buyouts, and Award Conditions modifications are just some of the possible solutions to consider. None of these have to be mutually exclusive. Mix and match as it suits your needs.
a) Repricing: Replacing underwater stock options with at the money stock options.
i) It is simple and effective.
ii) Simply replace options with the same number of options at a lower price.
iii) This is hated by most investors.
iv) Potentially costly from an accounting perspective.
v) May not provide the right solution for your long-term needs.
b) Exchange Options for:
i) Smaller number of at-the-money options
(1) Use different grant terms and vest dates to address short-term to mid-term concerns.
ii) Cash
(1) This may be a great short-term solution when a long-term solution cannot yet be fully designed. Cash is also a potential solution for lower-level employees with small-value options.
iii) Restricted Stock Units (RSUs)
(1) Reduces potential dilution, provides awards with downside protection (cannot go "underwater"). Should ideally provide a reasonable exchange rate to ensure a "like value" exchange under accounting rules.
iv) Discounted stock options/SARs:
(1) Use cliff vesting (e.g., 1-3 years) with automatic immediate exercise/settlement to address 409A tax implications.
(2) Consider the inclusion of a discount of 10%-20% from the current stock price to cushion against further stock price depreciation. Addresses short-term to mid-term instead of long-term.
7) Modified Stock Options grant methodology:
a) Grant options more frequently, in smaller grant sizes – immediately and every 3-6 months to capture lower/more volatile strike prices during the entire down-market period. Grant cumulative totals that reflect your annual intent for each year, or slightly higher, just more frequently than once per year.
b) Use different grant terms and vest dates to address short-term to mid-term concerns.
8) Restricted Stock/Units adjustments:
a) Begin granting RSUs instead of stock options.
b) Begin granting RSUs in additional to stock options (use different mix levels for different populations).
c) Provide CHOICE to employees – let employees decide whether they want to receive more RSUs or more stock options. It gives employees greater control to address their personal financial situation.
d) Use more frequent vest dates (monthly or quarterly) instead of annual.
e) Evaluate the inclusion of performance conditions that allow for the maximization or minimization of award size, based on longer-term performance.
9) Performance Stock/Units modifications:
a) Modify performance metrics if existing metrics are no longer deemed achievable due to significant uncertainty.
b) Recharacterize all, or a portion, of the PSUs to time-based RSUs and introduce with more frequent vesting (monthly or quarterly).
c) Use PSUs to provide an incentive for employees to over-perform to meet the company’s needs that are unique to this time period.
10) Immediately evaluate your Employee Stock Purchase Plan (ESPP).
a) Is the plan designed to weather a deep drop in stock price? Are share and value limits reasonably set to allow for plan continuation?
b) Is your share allocation deep enough to support a broad-based purchase at far lower grant prices than in recent years?
c) What happens to your plan if it runs out of shares? Does it automatically cancel?
d) How can you protect your plan, your employees, and keep shareholder support for the ESPP?
11) For companies with, and without, cash
a) If cash is currently an issue, consider using equity instead of cash to pay people. This allows the company to conserve cash to meet operating needs to sustain the business. In return, the company can issue more equity to employees, allowing future market growth to build far more value.
b) If cash is available, you may find that a smaller amount of cash will be appreciated at this time. Even amounts of 40-50% of the equity value may be compelling for many employees.
12) Execute, Recover, and Grow. In the end, this will pass. We will emerge smarter and stronger and better prepared for our successful futures.
These are unprecedented times. Now is the time for companies to consider taking unprecedented action with their equity/reward strategy.