409 _A_ by Levone


									        Section 409A
Real World Recommendations from
       Experts in the Field
   Introductions
   General Scope of IRC 409A
   409A Compliance & Equity Compensation
   Valuation Methodology
   Frequently Asked 409A Questions
   Audience Questions
   Elliot Williams (Moderator)
    Mirus Capital Advisors
       Elliot Williams joined Mirus in 1991, has been a Partner since 1997, and
        has served as President of the firm since 2000. Mr. Williams has worked
        on more than 60 advisory engagements for clients – negotiating,
        structuring, valuing and closing mergers, acquisitions, and financings.
        An expert on the Business Services Industry, over his career Mr.
        Williams has managed engagements in business process outsourcing,
        hosting, systems integration, staff augmentation, and trade show
        management. He has also represented clients in other industries
        including software, telecommunications, packaging and specialty
        coatings. Mr. Williams currently serves as the President of the
        Association for Corporate Growth, as an advisor to the boards of
        several entrepreneurial companies, and as an active member of the
        Boston Chamber of Commerce and the Alliance of Merger and
        Acquisition Advisors.
       Mr. Williams earned a B.S. in Business Administration from Babson
        College and holds Series 7 and 63 NASD certifications.
   Bas van der Brugge (Finance/Valuations)
    Senior Associate
    Mirus Capital Advisors
       Bas van der Brugge is a Senior Associate with Mirus, where he
        conducts Section 409As for clients. Additionally, he has participated in
        over a dozen M&A engagements at Mirus. Prior to joining Mirus, Bas
        was an associate and member of the Corporate Finance and Strategy
        Practice at McKinsey & Company in Amsterdam. While at McKinsey,
        Bas worked with the senior management of leading European and
        Asian companies on market analyses, company and project valuations,
        and to advise and structure joint ventures and strategic alliances for
        acquisitions and divestitures. He has worked extensively in the
        software, services, telecommunications, and transportation industries.
       Bas graduated with a Master of Science degree in Financial
        Econometrics from Erasmus University in Rotterdam, the Netherlands.
        In addition to being a CFA charter holder, he holds Series 7 and 63
        certifications from the NASD.
   Andrew Liazos (Legal)
    McDermott Will & Emery LLP - Boston
       Andrew Liazos heads the Firm’s executive compensation practice in the
        law firm of McDermott Will & Emery LLP.
       Andrew is ranked as a leading executive compensation and employee
        benefits lawyer by Chambers USA – America’s Leading Lawyers for
       Andrew is a faculty member of the American Law Institute-American Bar
        Association, a John S. Nolan Fellow of the ABA’s Section of Taxation
        and a frequent commenter on IRS proposed regulations and guidance.
       Mr. Liazos is a graduate of the University of Massachusetts and Suffolk
        University Law School.
   Alex Lifson (Tax & Accounting)
    Deloitte Tax LLP
       Alex Lifson is a Director in the Global Employment Services
        practice at Deloitte. Alex assists clients with numerous issues
        related to executive compensation and employee benefits. His
        practice is focused on designing and implementing equity
        compensation strategies, executive compensation issues in
        mergers and acquisitions, various retirement and incentive
        programs, deferred compensation arrangements and
        performance based compensation.
       Mr. Lifson holds a B.A. in Economics from Bates College, an
        M.B.A. from Boston University and an M.S. in Taxation from
        Northeastern University.
   Introductions
   General Scope of IRC 409A
   409A Compliance and Equity
   Valuation Methodology
   Frequently Asked 409A Questions
   Audience Questions
                   What is IRC 409A?
   Congress enacted 409A as part of the American Jobs
    Creation Act of 2004 in response to perceived abusive
    compensation practices
   IRC 409A applies to “non-qualified deferred
    compensation” (NQDC)
       Restricting the timing of deferral elections
       Limiting permissible payment events
       Restricting changes to time and form of payments
       Restricting certain funding vehicles
   Deferred compensation results in current income and is
    subject to an excise tax, when it is earned or becomes
    vested, if the plan does not meet specific requirements
             What is IRC 409A?
   Applies to employees, directors and “other
    service providers”
   Applies in addition to 451 constructive
    receipt rules
   409A contains very specific rules
    governing the timing of deferrals, timing of
    distributions, funding methods and various
    other aspects of deferred compensation
    How does the IRS define deferred
   Legally binding right to compensation received
    in one taxable year, with actual or constructive
    receipt of income in another
   Legally binding right does not exist if Company
    has discretion to reduce compensation after
    services are performed
   Legally binding right does exist if:
       Discretion is available only on a condition
       Lacks substantive significance
    What plans are subject to 409A?

   Definition is very broad and includes:
     Elective deferred compensation
     Non-elective arrangements (e.g. SERPs)

     457 (f) arrangements

     Certain types of severance

     Certain plans outside the United States
     What plans are subject to 409A?
   Example:
       Consultant prepares PowerPoint presentation for
        annual bonus
       Performance period for annual bonus is the
        calendar year
       Compensation Committee “approves” plan design
       Bonus plan document is drafted but is not formally
       No payment date is specified for the bonus
       Payment is made six months after the end of the
        calendar year
   Key issue: “Legally binding right”
    What are the exceptions to 409A?

   Customary payroll timing
   Short term deferrals
   Certain equity compensation
       Non-discounted options
       Restricted stock
       Stock Appreciation Rights (SARs)
   Restricted property
   Arrangements between partners and
   Separation pay arrangements
   Introductions
   General Scope of IRC 409A
   409A Compliance and Equity
   Valuation Methodology
   Frequently Asked 409A Questions
   Audience Questions
        What are the penalties for non-
   If there is a violation, affected service providers owe:
       Current tax on deferrals for current year and all prior years (to
        the extent not subject to a substantial risk of forfeiture)
       Interest at underpayment rate + 1% from original deferral date
       Additional tax of 20% of the taxable compensation
   If plan is not drafted correctly, all plan participants could
    be “affected” and all post-2004 deferrals taxable
   Date to amend plans for 409A compliance will likely be
    extended beyond 12/31/06
   Timing of service recipient’s deduction not affected
   Few employers providing tax gross-up payments
How does 409A affect Stock Options
           and SARs?
   Non-discounted options not subject to Section
   Similar treatment now extended to all SARs
       private and public companies
       cash and stock settled arrangements
   Exercise price may not be less than the “value”
    of the “service recipient stock” on the “grant
   Tax on vesting for discounted stock options &
   Concepts apply to LLCs and partnerships
                 What is the Grant Date?

   Grant date critical for measuring compliance
   Terms of the grant must be “irrevocably established”
       What about letter agreements to new hires?
   Compare to FASB Position under FAS 123(R)
       Board approval date is the grant date if:
            employee cannot negotiate key terms and conditions between the
             approval date and notification date and
            terms are communicated within a “reasonably short period of time”
             after the approval date
   Need for internal controls on granting practices
               What is the Grant Date?

   A “modification” triggers the grant of a new stock right
   Does a new stock right comply with 409A on re-grant?
       Option repricings
       Exception for M&A option exchanges
   An extension or renewal is treated as an additional
    deferral feature from grant date, so 409A applies
   Limited exception under proposed regulations allows for
    extended post-termination exercise period until
       end of calendar year or, if later
       two and one-half months
        What is Service Recipient Stock?

   Only “service recipient stock” qualifies for exception
   Covered entities:
       50% or more subsidiaries
       20% or more joint ventures with legitimate business criteria
   Covers publicly traded stock or, if none, the most
    valuable form of common stock in the aggregate
   Issues under the proposed regulations:
       preferred stock ineligible
       multiple classes of common stock
       non-publicly traded subsidiaries
         What is the Value for a Private
   Value determined "by the reasonable application of a
    reasonable valuation method" – what does that mean?
   Unreasonable to use
       a previously calculated value that fails to reflect all material
        information, or
       a calculation that is more than 12 months old
   Two primary safe harbors
       Written valuation report for illiquid stock by person with
        significant knowledge and experience - unavailable if:
            company more than 10 years old
            liquidity event is within 12 months after the option grant or
            put/call rights on stock
       Independent Appraisal
   Introductions
   General Scope of IRC 409A
   409A Compliance and Equity
   Valuation Methodology
   Frequently Asked 409A Questions
   Audience Questions
    What guidelines has the IRS given
          for 409A valuations?
   “Reasonable method, reasonably and
    consistently applied”
       the value of tangible and intangible assets of the
       the present value of future cash-flows of the
       the market value of stock or equity interests in similar
        corporations and other entities engaged in
        businesses substantially similar to those engaged by
        the corporation; and
       other relevant factors, such as control premiums or
        lack of marketability
How is a typical enterprise valuation
 different from a 409A valuation?

                           Model capital    Determine
      Determine Total
                           structure        common stock
                           (liquidation     valuation using
      Values (TEV)
                           preferences,     allocation
      using various
                           conversions,     method
                           options, etc).

                         Specific to 409A (and other
                        option plan related valuations)
What does a full valuation entail?
  Approach           Method

  Market Approach    Public markets
                     M&A transactions
                     Private placements

  Asset Approach     Liquidation value
                     Replacement cost

  Income Approach    Discounted cash flows
                     Scenario analysis
                     (Embedded) options

  Company Specific   Prior equity events
                     Other relevant factors
What complexities arise due to the
       capital structure?
                         Options                Series B        Series B
                        Exercised                Caps           Converts

           Series B     Series A           Series A        Series A
           Liq. Pref.   Liq. Pref.          Caps           Converts

 ($ MM)


  20                                                                         Series A

  15                                                                         Series B



       -    10     20    30     40    50     60    70      80     90   100
                               Equity value ($ MM)
    What are the different value
      allocation methods?
   Current Method
       Value common as if a liquidity event occurs today
       Apparently widely used, but only appropriate in limited
   Option Method
       Either Black & Scholes or binomial trees
       Depends on some critical inputs such as volatility and
        exit horizon
   Probability Weighted Expected Return
       Valuation analysis based on various exit scenarios
        (IPO, trade sale, liquidation)
       Highly dependent on a handful of assumptions
     How can you account for the
         evolution of value?        Scenario 1
                                    $ 150 MM


                 Year 2   60%
                $ 75 MM
          10%             10%      Scenario 2
                                    $ 50 MM
 Year 1
$ 40 MM   40%
                                   Scenario 3
                                    $ 0 MM
   Introductions
   General Scope of IRC 409A
   409A Compliance and Equity
   Valuation Methodology
   Frequently Asked 409A Questions
   Audience Questions
Frequently Asked Questions

    What 409A issues arise in M&A
Frequently Asked Questions

    How can IRC 409A impact my ability
     to go public?
Frequently Asked Questions

    Can I do the section 409A valuation
Frequently Asked Questions

    How does IRC 409A relate to
   Introductions
   General Scope of IRC 409A
   Compliance with 409A
   Valuation Methodology
   Frequently Asked 409A Questions
   Audience Questions
Audience Questions
                     Thank you
   This presentation can be downloaded at
   Presenter contact information:
       Elliot Williams, Mirus Capital Advisors
          williams@merger.com; 781-418-5932
       Bas van der Brugge, Mirus Capital Advisors
          brugge@merger.com; 781-418-5941
       Alexander G. Lifson, Deloitte
          alifson@deloitte.com; 617-437-2546
       Andrew C. Liazos, McDermott Will & Emery
          aliazos@mwe.com; 617-535-4038

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