Phantom Stock Plan

[401 Chaos]

Would appreciate thoughts or help on this. Company wants to put in a phantom stock plan for a couple of key employees without impacting actual ownership of closely held company. The plan is really intended to function / payout as a change in control bonus plan--i.e., participants receive cash or other consideration paid by Buyer if and only if there is a CIC as defined in Section 409A. (It is possible that some payout may be made upon a death or a 409A disability but likely that separation from service for those reasons will only simply result in delayed payment upon CIC within a certain period.) Accordingly, I think the plan should basically comply with 409A as it likely will pay out if and only if the participant remains employed through a 409A change in control of the company.

Does anyone see obstacles or problems with that general approach?

If not, my main question is whether there is any way to safely try and accomodate the possibility of an earn-out as part of the consideration. It may be that the company will decide to simply make this a straight cash plan even if there is a mix of consideration paid to actual shareholders. Still, I wonder if it would be possible to structure a phantom stock arrangement like this to track an earn-out, etc. provided it complied with general rules applicable to options or SARs, etc. The phantom nature of this arrangement though makes me hesitant to think the earn-out exceptions provided for real stock rights would apply here.

[Guest DKG]

Would appreciate thoughts or help on this. Company wants to put in a phantom stock plan for a couple of key employees without impacting actual ownership of closely held company. The plan is really intended to function / payout as a change in control bonus plan--i.e., participants receive cash or other consideration paid by Buyer if and only if there is a CIC as defined in Section 409A. (It is possible that some payout may be made upon a death or a 409A disability but likely that separation from service for those reasons will only simply result in delayed payment upon CIC within a certain period.) Accordingly, I think the plan should basically comply with 409A as it likely will pay out if and only if the participant remains employed through a 409A change in control of the company.

Does anyone see obstacles or problems with that general approach?

If not, my main question is whether there is any way to safely try and accomodate the possibility of an earn-out as part of the consideration. It may be that the company will decide to simply make this a straight cash plan even if there is a mix of consideration paid to actual shareholders. Still, I wonder if it would be possible to structure a phantom stock arrangement like this to track an earn-out, etc. provided it complied with general rules applicable to options or SARs, etc. The phantom nature of this arrangement though makes me hesitant to think the earn-out exceptions provided for real stock rights would apply here.

Your approach looks workable to me, and an earn-out paid on phantom stock should still fit within the "transaction-based compensation" exception of 1.409A-3(i)(5)(iv)(A):

Payments of compensation related to a change in control event... that occur because a service recipient purchases its stock held by the service provider or because the service recipient or a third party purchases a stock right held by a service provider, or that are calculated by reference to the value of stock of the service recipient (collectively, transaction-based compensation)...

If your phantom stock arrangement would pay compensation upon a qualifying 409A CIC event that are calculated by reference to the value of the stock, I don't see why you coudn't pay out the consideration as received.

[jpod]

Sounds to me like you might have a short-term deferral arrangement that is completely exempt from 409A, and I would proceed down that road in my analysis.

[401 Chaos]

Thanks DKG. The phrase you highlighted was the one that was giving me some pause. I wondered whether that might be read in some way to require use of actual shares rather than phantom shares but I haven't seen anything to indicate that and, as you note, I think is phrased broadly enough to cover earn-outs on phantom shares.

Thanks Jpod. S-TD exemption was (is) the original thinking. I guess it wasn't absolutely clear to me that if you had an earn-out attached to the payment stream so that it carried over to future years that would clearly fit within S-TD. Does S-TD work so long as any earn-outs are basically paid immediately upon satisfying the earn-out requirement--i.e., although you have a vested right to a contingent earn-out, you get it if and only if the earn-out target is met?

Thanks

[jpod]

You said "earn-out," so to me that implies that there are conditions that might create a SRF. In effect, you could have a series of short term deferrals, one for the basic payment and others tied to each earn-out increment. As long as payment is made within the 2-1/2 window for each earn-out increment, I think you escape 409A. All of this is to be distinguished from a situation where payment is merely spread out over time, or if the risk of forfeiture tied to the earn-out does not satisfy the SRF definition in the regulations.

I am not suggesting a result; I am merely suggesting how I would analyze this if I had all the facts.

[401 Chaos]

Thanks. I agree with you. There would definitely be conditions tied to the earn-out based on company performance so I think that would work. In all likelihood at least some portion of the earn-out would likely be earned but there would be no guarantees. The participant would not be required to remain employed through the earn-out payments, just that the company would hit the targets.

I just wanted to be sure that it would comply with the 409A earn-out exception if for some reason the arrangement were subject to 409A. Thanks.