Change of control agreements – a quick guide for CEOs, CFOs, and other senior executives
You are a C-suite officer or senior executive and your company is facing an acquisition. How do you protect yourself or even advance your position in the event of a “successful” acquisition and change in control of your company?
DILEMMA FACED WHEN YOUR COMPANY IS “IN PLAY”
You could be a CTO, or a CMO, or COO, VP Sales, Marketing or Information Technology and perhaps you will face loss of your position in this change of control. At the least you will have a new CEO, new executive suite, and new reporting structure, where you will have to “earn your wings” – prove your worth, yet again. You may face a circumstance where the new control structure seeks “administrative efficiencies” and your early exit from the successor entity.
On the other hand, you may have important knowledge, important contacts, important relationships that form a key part of the assets being acquired. Will you be fairly compensated for all that you are asked to bring to the new owner?
Very often in a change of control, senior management is focused on the day to day, and doing what is right for the company, and keeping up with the rapid pace of the acquisition, and … personal needs are not properly addressed.
SELF-ASSESSMENT – YOUR IMPORTANCE TO THE DEAL
Early on in and acquisition process, when a company is in play, the C-suite or senior executive ought to carefully assess his or her own value to the ongoing and future enterprise and seek both assurance and protection in a negotiated retention agreement.
This is not something to leave to the last minute or to allow to be pushed off into the future. All to often, last minute translates to “take it or leave it”
In such a negotiation, the executive should certainly raise the need to recognize past contributions made to the enterprise, but more important how the executive’s retention could be critical to the success of any acquisition. If the owners are to achieve the value sought in an acquisition, then key executives critical to the value of the enterprise need to stay in place.
As part of such a negotiation, the executive should “test the waters” for other opportunities, and indicate that early departure is possible if a proper retention package is not offered.
WHAT IS THE PROPER RETENTION PACKAGE?
The right package should reflect both past contributions and the importance the executive holds to ongoing operations.
I have had negotiations, where, on occasion, one or two executives were critical to the success of the acquisition. In one case, over 90% of the critical work force reported to one executive, who always put company first, ahead of his own needs. This executive was critical to the company’s key technology and markets as well as personnel. If that executive left or did not continue after the acquisition, it might reduce the value of the enterprise by 50% or more. Yet, in that case, before I took up the representation, the executive’s share of the company at sale was less than 1%. The owners hated to increase the executive’s share of the sale, but faced with either a negotiated retention agreement or the risk of departure, and thus, the possible loss of the sale or dramatic reduction in the sale price, the executive’s share was increased…dramatically.
Clearly, the right package should have certain important elements
- Significant equity of the target company to the executive,
- Liquidity for the executive on the levels of liquidity offered owners
- Properly structured equity, tax favored for capital gain taxation
- Proper severance in the event of early termination after the acquisition
- The ability to trigger severance if the executive’s position or responsibilities are reduced
- Proper structuring to avoid potential excise tax for parachute payments under IRC §280G.
CHANGE OF CONTROL AGREEMENT TO PROTECT YOUR INTERESTS
In close, if you have worked hard to make your company successful, you need to consider proper recognition and protection. Perhaps you had to weather hard years. Perhaps you and your family made sacrifices. Perhaps you made key contributions along the way. Now, there is a prospect that your hard work, sacrifices and contributions may at last pay off for the company – result in a “success event” – an acquisition and liquidity event for the company’s owners. If that is the case, you too deserve a fair share in that liquidity event. You also deserve protection in the new regime that will follow. It is best, early in this process, to seek that share and those protections in a negotiated change of control / retention agreement that reflects your own interest and needs.
By Robert A. Adelson, Esq. is a corporate and tax attorney and partner in the Boston, MA law firm Engel & Shultz LLP. He represents C-suite and senior executives in employment, equity, severance and change of control agreements.