Where plan design tends to go wrong
Most problems in an executive compensation plan come from tax and approval issues rather than from the economics. Federal tax rules on deferred compensation are strict about when payments can be elected and made, and a failure can shift significant taxes and penalties onto the executive even when the error was the company's. Stock options generally need an exercise price no lower than fair market value on the grant date to stay outside those rules, which is why private companies obtain independent valuations. Payments triggered by a change in control can carry excise tax consequences once they pass certain levels. Equity that was promised in offer letters but never approved by the board is another frequent source of disputes.
Inputs for designing the plan
Gather the company's governing documents, any existing equity plan and award agreements, the capitalization table, and current employment agreements or offer letters for the executives involved. Note what has been promised informally, since promises in emails can create claims. Decide what the plan should reward, such as revenue, profitability, a sale of the company, or simply staying, because the metrics drive the structure. For an LLC, profits interests and similar tools work differently from corporate stock. If the company is public or preparing to be, disclosure rules and shareholder votes on pay become part of the design.
Approvals, clawbacks, and the executive's side
In a first review we look at which body must approve the plan, whether shareholder approval is needed for tax or exchange purposes, and how awards will be documented. Companies listed on a U.S. exchange must maintain a policy for recovering incentive pay that was awarded based on financial results later restated, and some private companies adopt similar terms voluntarily. We also look at how the plan treats terminations, resignations, and a sale of the company, since those are the moments disputes arise. If you are an executive reviewing a plan offered to you, we focus instead on what you are giving up in exchange for the award, such as restrictive covenants or a release of claims.
