Ø      Platform, Position, Launching Pad

    Ø      Cash Compensation and Benefits

    Ø      Equity: Corporate/Tax Structure

    Ø      Termination, Severance, Non-Compete

    Ø      Good Vibrations      

By Robert A. Adelson, Esq.
EXAMPLE (Hypothetical and Fictitious)

Engineer Bradee                                                            MicroscopicSoft, LLC

Employee Offer Sheet:                                              Company Profile:

Salary: $225,000 plus bonus                                                         Bus: Software

Benefits: HMO Med/NoDent/                                                         HQ: Eugene, OR

401K, Life/Dis insur  Perqs: blackberry               Assets: $2 mil net (12/31/09)

Term:  At Will                                                                   Sales: $10 mil FY ‘09

Severance: 3 mos                                                           P(L): ($0.5 mil)

Expns : Relocation                                                         Stock : 20 mil o/s LLC units

Pos: EVP COO                                                                                      Exchange: Private

Outside Bds:  None                                                                            Employees : 50

Equity : 100,000 units (NQ)                                                         Est.: 2002  

Full-time Employment with Emerging Hi-Tech Company

            Thomasina Bradee, PE of  Wellesley, MA, is an executive considering a job move.  She is now VP Sales with the Harris Graphics Division of ZEN Development Corp. a local software company recently acquired by giant Big Blue Machines, Inc. (BBM)

            Bradee recruited the sales team and developed marketing and channel strategy for Footnotes, Zen’s top sales product, and has been offered the EVP & COO spot with MicroscopicSoft, LLC, a young Oregon software company.  Founded by Gyl Bates, Microscopic focuses on products similar to Footnotes and has backing from Bates who head a large company also located in the Northwest with a similar name.  Microscopic still has $3 million in assets (including a Company facility in Eugene) net of long term liabilities.  It has experienced recent losses from operations this past year, its burn rate increasing, but it also believes itself well positioned for a possible liquidity event next year.

            The package offered to Tom includes $225,000 salary (50k deferred) with 20% bonus, plus relocation expenses and options for 100,000 units vesting over 5 years.  Fair market value is now estimated at $0.50 per unit which would be Tom’s strike price.

            Bates is anxious for Tom to start.  Bates particularly wants her to attend a big trade show for Microscopic in Chicago sponsored by Alex Blue, showcasing Microscopic among Blue software clients.  As Tom packs for Chicago, she does have some concerns about uprooting her family and sale of her home purchased at the height of the market.  She is also concerned about recent sales results, reception of Microscopic’s latest product offering, and some articles in trade literature mentioning Bates’ frustration and listing Microscopic as a potential takeover target for others in the footnotes market.  But Tom is unsure of her position with Zen, now part of BBM, she likes the challenge, and with more information she thinks she can help Microscopic’s market position.

            Tom just gave her current boss BBM’s Gertner Louis, notice of her plans.  She never had an employment contract before, and it occurs to her, she ought to have someone look over the “term sheet”.  Gyl e-mailed and asked her to sign and return.  Hence, on a friend’s referral, we have received Tom’s car phone call on the way to the airport. 

BEYOND THE HANDSHAKE . . .

IS AN EMPLOYMENT CONTRACT

REALLY  NECESSARY?

QUESTIONS OF THE EXECUTIVE:

¨     When does asking for a contract make the most sense?

¨     How and When to ask for a contract if not offered?

¨     Will raising this now kill the job offer?

¨     How and When to uses a lawyer or advisor?
(Won’t a Lawyer kill the deal for sure?

¨     Who negotiates and how does it proceed?

¨     What documents are involved?

¨     What will this cost?

¨     What if the Company won’t change anything?

QUESTIONS OF THE COMPANY:

¨     When does offering a contract help the Company?

¨     Will a contract open the company to liability?
(Isn’t at-will employment best for all?)

¨     Will a contract’s terms cause Company problems -
with Existing Employees? . . . with Investors?

Besides Compensation . . . Other Key Terms in Negotiating Executive Employment Contracts

«Position, Platform and Launching Pad

1.      Title and Position; Reporting

2.      Board of Directors Membership

3.      Duties and Responsibilities

4.      Support; Budget

5.      Outside Affiliations

6.        Term of Agreement

7.        Renewals; Exit (“rip-cord”)

«Relocation and Expense Reimbursement

1.      Temporary Living and Travel

2.      Permanent Relocation

3.      Tax Gross-Up

4.      Business and Professional Expenses

5.      Licenses, memberships

6.      Other costs including contract costs

«Termination and Severance

1.      Early Termination by act of Company

2.      Early Termination by act of Executive

3.      Cause, Cure, Notice

4.      Severance – relation to surviving covenants

«Change of Control

1.      Form and Amount of Benefits

2.      Parachute Exceptions, Caps, Tax gross-up 

«Non-Competes and Restrictive Covenants

1.      NDA/Confidentiality Agreements

2.      Assignments of New Inventions

3.      Non-Solicitation

4.      Non-compete

«Good Vibrations

     1.      Good Contract can be very valuable, but it does not itself make a good job, nor is it a substitute for good intelligence.

     2.      If your informants and gut tell you it’s a winner be prepared to concede on contact issues.

HOW DO WE STRUCTURE EXECUTIVE

CASH AND EQUITY COMPENSATION

AS A WIN-WIN FOR  BOTH  SIDES?

QUESTIONS OF THE EXECUTIVE:

¨     The Big Boys get signing bonuses – can you get one here?  Can you justify a large salary increase as well?

¨     If you want to avoid taxes, how do you structure deferred salary to avoid the tax hit and still get paid?

¨     How do you protect your bonus and assure it is paid?

¨     When does taking equity as your pay make the most sense?

¨     What types of stock or options can the company offer?�
What’s the value?  How is this equity taxed?

¨     How do you avoid dilution?  What other structuring issues do you need to protect your equity stake?

QUESTIONS OF THE COMPANY:

¨     When is a Company smart to offer equity or bonus pay?

¨     Can this equity be paid based on performance? or loyalty?
Can we measure performance? how much stock to give?

¨     What if things don’t work out:  Can we get the stock back?
What if Executive dies? Quits? What if we sell the Company?

¨     Will giving stock now hurt us later? in seeking financing?
in morale with current staff? in recruiting new talent?

«Cash Compensation

      1.      Signing Bonus

• Evidence Commitment by Employer
• Replace lost benefits (golden key)
• Payable in Cash, Equity, Other

      2.      Base Salary

      3.      Deferred Compensation

• Funded or Unfunded
• Convertible Debt
• Rabbi Trust or Secular Trust

     4.      Bonus Income

• Guaranteed or Discretionary
• Performance Based

«Fringe Benefits

      1.      Medical, Dental and Health Benefits

      2.      401(k), Pension, Profit Sharing Plans

      3.      Life and Disability Insurance

      4.      Vacation, leave; Company Perquisites

«Equity Incentives:  Based on Tax Structuring

     1.      Restricted Stock Purchase Plan

• IRC §83(b) Election

     2.      Stock Option – Qualified (§422) ISO

     3.      Stock Option – Non-Qualified

     4.      Equity Based Compensation Plans

• Phantom Stock & Stock Apprec. Rts (SAR)
• IRC 409A compliance

«Key Terms in Executive Equity Negotiations

     1.      Vesting and Change of Control

     2.      Valuation and Anti-dilution

     3.      Stock Option Terms and Exercise

     4.      Purchase Terms and Covenants

     5.      Transfer Restrictions & Shareholder Agreements  

Negotiating Severance and The Separation Agreement

1. 1.   Severance Pay and Benefits

• Amounts and timing
• Allocations to Emotional Distress, Attorneys fees and medical expenses to save taxes
• Payments for attorneys fees, outplacement and other specific costs to enhance severance
• Medical coverage
• Other Employee Benefits
• Duration of severance

1. 2.   Job Search and reputation

• Outplacement
• Office Space
• Inquiries from contacts and potential employers
• References
• Confidentiality
• Mutual non-disparagement

1. 3.   Releases

• Mutual release
• Legal rights
• Rights to enforce settlement

1. 4.    Enforcement
2. 5.   Cooperation

ABOUT THE SPEAKER AND PRESENTATION . . .

These materials were prepared by Robert A. Adelson, Esq., Partner at Engel & Schultz, LLP, 265 Franklin Street, Suite 1801 Boston, MA 02110, (617) 951-9980, fax (617) 951-0048. His e-mail is radelson@engelschultz.com .  Mr. Adelson is a graduate of Boston University, Phi Beta Kappa, Northwestern University Law School in Chicago where he was a member of the Law Review, and New York University with an LL.M. in Taxation.  He is a member of the Massachusetts, New York and U.S. Tax Court Bars.

Robert Adelson began his career in 1977 as an associate at major New York City firms before returning home to Boston in 1985 where he’s been a partner in smaller firms, joining his present firm as senior business attorney in 2004. Mr. Adelson is   specialized in corporate, tax, employment, commercial contracting and intellectual property law.  He frequently represents employees and executives negotiating their employment terms, stock, options, relocation, non-competes, termination and separation agreements.  He also represents startup and smaller companies in software, medical device and other technology-based fields, independent consultants with compensation and stockholder arrangements, incorporation and liability protection, intellectual property protection, and in vendor, client and subcontractor contracting arrangements.

Mr. Adelson’s  law firm, Engel & Schultz, LLP, has 6 attorneys based in Boston.  The firm complements Mr. Adelson’s work in business and tax law with seasoned attorneys in family, probate, real estate and litigation matters. 

            Mr. Adelson is a frequent speaker at business forums and Chairman of IEEE Boston Entrepreneurs Network www.boston-enet.org .  Further information on Mr. Adelson’s background and his past published articles is available at his law firm website.  To view articles, see http://www.engelschultz.com/index.php/category/publications/  or http://robadelson.wordpress.com/

The speaker wishes to thank Marg Balcom for the invitation to speak on the topic of “Negotiating Compensation and Employment Contracts” for the Boston Chapter of ExecuNet at Dedham Community Center, Dedham, Massachusetts, on April 12, 2010.

The example on page 2 is hypothetical and fictitious but the questions on page 3 and 6 are drawn from actual client questions.  The purpose of the example and materials, as developed by Robert Adelson, is solely to illustrate planning concepts and stimulate meeting discussion.  The purpose of the remainder of these materials is to illustrate and offer rough outlines of broad areas of corporate, tax, contracts and business law which affect executive employment contracts, stock and compensation in high technology and more traditional fields.  Thus, it is hoped these materials will be informative to those in attendance.  These materials are not legal advice and not intended as any substitute for professional advice or counsel in a particular case. 

Copyright (c) 2010  Robert A. Adelson.  All rights reserved.

  By Robert A. Adelson

1.         Cash Compensation and Benefits

«Cash Compensation

• Base Salary
• Deferred Compensation
• Bonus Income

«Fringe Benefits

• Medical and Pension Benefits
• Insurance coverages
• Vacation, Leave, Company Prerequisites

2.       Equity Incentives, Tax Benefits and Structuring

« Equity Incentives: Based on Tax Structuring

• Restricted Stock, 83(b) Election
• Stock Options – Qualified (ISOs), Non-Quals
• Equity Based Compensation Plans
  • Phantom Stock & Stock Appreciation Rights (SARs)
  • IRC §409 Deferred compensation rules
• LLC Capital Interest
• LLC Profits Interest

« Key Terms in Executive Equity Negotiations

• Vesting and Change of Control
• Valuation and Anti-Dilution
• Stock Option Terms and Exercise
• Purchase Terms & Shareholder Agreements

3.       Position, Platform, and Launching Pad

• Title and Position
• Duties and Support
• Outside Affiliations
• Terms of Agreement & Exit

4.       Relocation and Expense Reimbursement

• Temporary Living and Travel
• Permanent Relocation
• Tax Gross-Up
• Business and Professional Expenses
• Other costs including contract costs
   

5.       Change of Control

• Form and Amount of Benefits
• IRC 280G, 4999. 409A issues
• Parachute exceptions / Caps
• Tax Gross-up

6.       Termination and Severance

• Cause, “Good Reason”, Cure, Notice
• Severance – relation to surviving covenants

7.       Non-Competes and Restrictive Covenants

• Confidentiality & Assignments
• Non-Solicitations – Customers, Employees
• Non-Compete

8.       Opportunities for Negotiation

          When you are on the job

• Changes in your Employer
• Changes in your responsibilities
• Achievements, establishing yourself

9.       Preparing for the negotiation

• Keeping records of your accomplishments
• Showing how you added value to company
• Independent support for your position
• Bargaining tactics
• Setting proper stage for negotiation

10.     Understanding your Employers BATNA

          (Best alternative to Negotiated Agreement)

• Employer’s alternatives if you weren’t there
• Are you unique – do they really need you?
• What cost?  How long to get replacement?
• Would operations suffer – what cost to employer?

11.     Knowing your own BATNA

• Do you have attractive alternative options
• Could you easily get better job, rate, conditions?
• Would you be happier elsewhere – job evaluation
• Could you go an extended period without a new job?

12.     If main goal is salary increase and

Company has freeze policy,

other approaches to take

• Seek non-cash benefits, items in lieu of salary
• Negotiate next year’s salary or set time for review
• Seek deferred compensation (if non-violative of freeze)

13.     Negotiation is worth the effort

• Employer rarely makes best offer – need to seek it
• You appear stronger, negotiating in constructive way

14.     How to Negotiate, How to succeed

• Engage counsel, be prepared to negotiate from beginning
• Maintain flexibility; even if you don’t at first succeed,

there may be a future occasion to “revisit” the issues

About the Presentation

      1.   The outline was prepared for the webinar, arranged by Taariq Lewis, for MIT Sloan CEO Network with focus on employees / executives on the job.  This seminar also represents a portion and overview of the detailed seminar outline and presentation materials Robert Adelson prepared at the request and for national publication by ExecSense Webinars (formerly Reed Seminars) www.reedlogic.com/   of San Francisco, CA, a recognized leader in seminars for executives and attorneys. These materials also offer a preview of the full seminar materials.

1. The full seminar materials include numerous case studies, discussion of why the topic is important and how and when to negotiate, things to watch out for , pitfalls and ramifications of failing to follow suggestions made, a dozen frequently asked questions and a sample employment agreement.  The materials include a 60-minute presentation by Mr. Adelson.

1. More information on this seminar is available by ExecSense Webinars under the title What to Know Before Negotiating Your Next Raise, Compensation Plan and/or Employment Agreement. The CD is available from ExecSense Webinars at  http://www.execsense.com/details.asp?id=412 

 The author also welcomes executives desiring representation in the areas of employment and equity agreements, termination, severance, change of control, relocation and restrictive covenants. Contact information to reach the author, Robert Adelson is on the next page.

 About the Speaker

 Robert Adelson brings over thirty years of experience to his work representing executives negotiating employment agreements, compensation and equity arrangements. He began as an associate at major New York law firms Dewey Ballantine and Weil Gotshal & Manges, before returning home to Boston in 1985 where he has since been a partner in small and medium sized firms before joining his present Boston law firm in 2004. He holds degrees from Boston University, B.A., summa cum laude, Phi Beta Kappa, Northwestern University (Chicago), J.D., Law Review, New York University,  LL.M. in Taxation.  He is a member of the bar in Massachusetts and New York.

1. Robert Adelson is a frequent speaker and author of numerous published articles in the areas of employment agreements, non-competes and restrictive covenants, compensation, stock, options, phantom stock and executive equity terms and arrangements.

1. Robert Adelson has represented a wide range of executives: CEOs, COOs, CSOs, CTOs, CMOs, CFOs and numerous Vice Presidents, taking or changing positions in Massachusetts and across the US.

 Thank you,

Robert Adelson

ROBERT A. ADELSON, ESQ.

Engel & Schultz, LLP

265 Franklin Street, Suite 1801

Boston, MA 02110

(617) 951-9980 EXT. 205

FAX:  (617) 951-0048 

E-mail:  radelson@engelschultz.com

Blog:  http://robadelson.wordpress.com/

Webpages -

http://www.engelschultz.com/index.php/attorneys/partners/robert-adelson/

http://www.engelschultz.com/index.php/category/publications/

At Will Employment and Exceptions

1. Massachusetts is at will employment jurisdiction

• Employee may resign or Employer may                                  terminate employment at any time
• With or without notice
• For cause or reason or without cause or reason
• With obligation to pay wages or accrued vacation pay and expenses through date of termination
• No right to continued employment
• No right to severance pay after termination
• 2. Presumption employment is At Will

• If nothing said or written and if no exception applies                      employment is at will
• 3. Exceptions to At Will doctrine – Contract

• Written Employment Agreement can supercede at will employment
• Terms of agreement on term, severance will control

4. Exceptions to At Will doctrine – Implied contract

• Offer letters
• Employee handbooks
• Policies
• Practices
• Oral promises
• Promissory Estoppel – detrimental reliance

5. Vigilence of employers to avoid Implied contract

6.  Vigilence of employers to avoid claims for unemployment compensation for extended periods

• Specific termination provisions in Offer letters
• Specific termination provisions in employment contracts and Employee handbooks

Wrongful Termination by Statute

1. Termination for the wrong reason

• At Will employee can be terminated for no reason or any reason
• But cannot be terminated for an unlawful reason
• 2. Discrimination

• Age
• Race
• Gender
• National Origin
• Religion
• Disability
• Sexual Orientation
• Military status
• 3. Violation of Other Statutory Laws

• Civil Rights
• ERISA
• Equal Pay
• Family and Medical Leave Act
• Invasion of Privacy
• Plant Closings/ Takeovers
• Sexual Harassment
• State and Federal Tort Claims
• Wages and Hours
• Whistleblower Protections
• Worker’s Compensation

Tort, Equitable and Common law Claims

1. Implied Covenant of Good Faith and Fair Dealing

2. Violation of Public Policy

3. Negligent Hiring and Supervision

4. Interference with Contractual or Advantageous Business relations

5. Assault and Battery, False Inprisonment

6. Misrepresentation, Deceit and Fraud

7. Infliction of Emotional Distress

8. Fiduciary Rights of Minority Shareholders in closely held Corporation

Damages in Employment Termination

1. Contract Damages

2. Tort Damages

3. Statutory Damages

Demand Letter

1. Factual Background

2. Legal Claims

• Implied Contract
• Discrimination
• Other Statutory violations
• Good Faith and Fair Dealing
• Tort Claims

3. Demands

• Additional Consideration
• Changes from separation Agreement
• Attorney’s fees

4. Litigation

• Deadline or recourse to litigation
• Notice to preserve electronic records

Employment Litigation

1. MCAD filing requirements for discrimination claims

2. Complaint – Claims made and their survival

3. Discovery – plan to gain information to enhance case

4. Motions and briefs

5. Trying the case

Negotiating Severance and

The Separation Agreement

1. Severance Pay and Benefits

• Amounts and timing
• Allocations to Emotional Distress, Attorneys fees and medical expenses to save taxes
• Payments for attorneys fees, outplacement and other specific costs to enhance severance
• Medical coverage
• Other Employee Benefits
• Duration of severance

2. Job Search and reputation

• Outplacement
• Office Space
• Inquiries from contacts and potential employers
• References
• Confidentiality
• Mutual non-disparagement

3. Releases

• Mutual release
• Legal rights
• Rights to enforce settlement
• 4. Enforcement
• 5. Cooperation

ABOUT THE SPEAKER AND PRESENTATION

These materials were prepared by Robert A. Adelson, Esq., Partner at Engel & Schultz, LLP, 265 Franklin Street, Suite 1801, Boston, MA 02110, (617) 951-9980.        Fax (617) 951-0048. E-mail:radelson@engelschultz.com Website:  www.engelshultz.com Mr. Adelson is a graduate of Boston University, Phi Beta Kappa and Northwestern University Law School in Chicago where he was a member of  Law Review.  He also has an LL.M. degree in Taxation from New York University and is a member of the Massachusetts, New York and US Tax Court Bars.

Robert Adelson began his legal career in 1977 as an associate at major New York City law firms, first Dewey Ballantine and later Weil Gotshal & Manges, before returning home to Massachusetts in 1985, where he has been a partner at several Boston firms before joining his present firm as senior business law partner in 2004.  Mr. Adelson is specialized in corporate, taxation, contracts and intellectual property law. His clients are (1) startup and early stage companies; (2) officers, employees and executives; (3) consultants and service providers; and (4) family businesses.  Working with employees and executives, in addition to issues of employment termination, wrongful termination and severance negotiations, Mr. Adelson drafts, negotiates and advises clients on Offer letters and employment agreements; Noncompete, confidentiality, restrictive covenants; Stock, options, SARs and phantom stock; Issues under IRC §409A; Relocation, tax gross-ups, recruitment issues; Change of control issues; Severance, retention, termination agreements; Consultant, director, service agreements.

Mr. Adelson’s law firm, Engel & Schultz, LLP, is a small but broad service law firm of 6 attorneys in Boston.  The firm complements Mr. Adelson’s work in business and tax law with seasoned attorneys in litigation, real estate, family and probate matters.

Mr. Adelson is a frequent speaker at business forums and author of numerous published articles including articles on employment termination and employment negotiations. For articles, see http://www.engelschultz.com/index.php/category/publications/ For further information on Mr. Adelson’s background, see http://www.engelschultz.com/index.php/attorneys/partners/robert-adelson/

The speaker thanks Annette Reynolds, for the opportunity to speak and present to this meeting of 128 Innovation Capital Group / Blitztime on the subject of “Employment Termination and Severance Negotiations” from Boston, Massachusetts, on September 24, 2009.

The purpose of these materials is to to offer an outlines on the subject matter of the presentation to officers, executives and employees and ssome business owners on the issues of employment termination, wrongful termination and severance negotiations. Thus, it is hoped these materials will be informative to those in attendance.  These materials are not legal advice and not intended as any substitute for professional advice or counsel in a particular case.

Boards and CEOs don’t like executives who say, “Remember, that employment agreement I signed when I came aboard?  I’d like to renegotiate.”  At the same time, an agreement that was barely acceptable at the time of hire may now be such a source of anger, it is detracting from commitment and drive.  In our work in complimentary fields, the position of the authors is that it is really in the interests of both parties to deal with the issue and move on or for the executive to move out.

This article will discuss circumstances under which it is appropriate to ask for a renegotiation, what to renegotiate for, and how to negotiate.  The authors also share some of our experience from the field of executive employment law and the field of executive management and coaching.

WHEN IS IT APPROPRIATE TO ASK FOR A RENEGOTIATION?

At the time that the initial agreement was formulated, both sides had incomplete information about each other.  New and important information not available at the time of hire can be the trigger to ask for a revision of the employment contract.  There are three broad categories of new information: (1) the company has new information about the leader, (2) the leader has new information about the company and other job prospects, (3) there are changes in the executive leadership or company prospects that effect the executive’s position.

• The Company Has New Information About the Leader.

All hiring decisions involve risk, even internal promotions.  The risk for the company is that the leader will fail to achieve job objectives.  That the failure was one of executive’s inability to meet the needs expected or incompatibility to work with the team or other parties needed for success.  An important victory gives the company new information that its gamble was a prudent risk.

This victory is not always achieving the objective set by the company.   A victory can be the establishment of a positive track record with the company.  This may judged to have occurred  if the executive has shown mastery of the mission and an ability to work with others and motivate staff to the tasks set.  Sometimes victory is not possible because of hurdles that arose beyond the executive’s control, but if the executive is moving his department in the right direction and become compatible with those he deals with, the company may judge this a victory in making a solid hire that will pay off in the long run even if not immediately.

Opening up discussions in the wake of an important victory is the most powerful way to begin renegotiation discussions.  At this point the executive is no longer an unknown commodity.  He or she has proven to be a good manager and contributor to the operation – the hiring has proved to be a good one and the company wants to keep you in place and motivated to continue the path to success.

A second reason why the wake of victory is a good time to begin discussions is that the company knows that your victory makes you more desired in the market for talent.  The threat of leader departure is heightened.

• The Leader Has New Information About the Company and job prospects

Just as the Company took a chance with the executive not knowing if he or she would work out, the executive too did not know if success would occur.

In achieving a victory or mastery of his or her tasks and position, the executive acquires additional information besides knowledge of that success.  The executive is now on the inside and can acquire knowledge of the value of that success to the company. That knowledge is not limited to the revenue and profitability derived from the executive’s achievement, but also the history of the position, whether others have tried and failed and the true value that the executive’s retention means to the company.

As indicated above, if the executive accepted a position when his or her bargaining position was not the best and accepted terms barely acceptable, the knowledge acquired on the job may enhance the ability to make a case for renegotiation when the victory is achieved.  This is even more the case if the executive is approached by recruiters and has prospects with other firms and determines his current deal with the company is below market.

For example one of our clients was a VP Sales who accepted terms and relocation of his family across the country and accepted far less in terms and equity than we sought for him in negotiations.  He had no other offer and accepted these terms out of necessity.  However, a year later after victory was achieved, we were able to re-open negotiations over points previously sought unsuccessfully in the original negotiation.  At the time of that renegotiation the company the company was ramping up toward a liquidity event.   The executive was now a known and valued player.  The company did not want to risk a disruption.  The executive knew the value he brought to the company, and knew too his deal was below market.  If he could not enhance his share in success with the current employer other suitors could offer a better option.  In those circumstances, re-negotiation offered the best course for both sides.

Another subcategory of information about the company comes when the leader knows that the employment contract lacks internal equity and that knowledge is sapping morale.  Chief Human Resource Officers, Chief Financial Officers, and Chief Legal Officers all have legitimate reasons for knowing the terms of employment contracts negotiated by the company.  If the Chief Marketing Officer is going to get two years salary continuation plus a choice of executive outplacement services and the CFO is going to get six months severance plus a three month outplacement workshop,  that is an internal inequity that can sap morale..

• Changes in executive leadership and company mission or prospects

Changes in reporting relationships can all trigger a request for renegotiation of the employment contract.  For example one of our clients was VP Development for a chemical company.  The CEO was fired by the Board and replaced by a venture capital partner who was not as familiar with the industry as the VP Development. This new CEO had a track record of having a short temper.  In the wake of this new decision, the CEO and the Board reluctantly agreed to a change of employment contract.

Changes in corporate strategy can also trigger renegotiation discussions.  The classic example is that at the time of hire, the strategy was to aggressively pursue acquisitions and grow.  The new strategy is to position itself to be acquired.

Under circumstances of such change, the Company may want to avoid further disruption as it absorbs the new CEO and corporate strategy.   Likewise, when a company is “in play” for acquisition, retention of core management is key to value retention for the acquisition. With those or other such changes in company strategy and mission, it’s right and appropriate for an executive to seek the security of some form of retention incentive to compensate for the new risks he or she is asked to take.

We find that leaders are too optimistic about their ability to adapt to new strategies and reporting relationships.  The first victories or positive track record were achieved working with the prior CEO or prior strategy or circumstances.  The executive now faces a risk that his or her success will not be repeated.  This could happen after a new CEO is established and wants “his team” and seeks the executive’s replacement as a matter of convenience.  Getting the advice of an outside counsel who knows the industry and knows the leader can be useful to overcome this natural tendency to delude oneself that “there isn’t any mountain I can’t climb.”   Such counsel can advise when the time is right to seek appropriate protections under the changed circumstance

WHAT TO NEGOTIATE FOR?

In the initial discussions, its wise to have and executive or management coach involved, but certainly when discussion evolve to the point where the executive will be reviewing or suggesting employment terms it is wise for the executive to then retain the services of an attorney who specializes in employment law to strategize what ought to be renegotiated and what is not worth renegotiating.

• Salary and bonus changes, often tied to sales or profit growth, including the chance for a “break-out bonus” for extraordinary success well in excess of target growth
• Employee equity – stock, options or phantom stock or a mix of them – in amounts appropriate to value employee brings to the company
• Tax favored equity to bring employee greater take-home pay.  This involves the use of alternative forms of equity to structure income at capital gains rates, far lower than ordinary income and avoiding payroll taxes wherever possible.
• Vesting arrangements on equity to take proper account for corporate changes and employee termination – so that earned equity is retained with a fair chance for the executive to derive benefit
• Title, responsibilities, reporting and level of support (which may including personal assistant, number of reports, and budget)
• Visibility—permission to join the Board of a non competing company, payment of dues for a professional association or to attend a national conference.
• Reduction in the duration and increased focus (narrowing) of non-compete and restrictive covenants.
• Salary continuation in line with company norms.
• Termination protections including executive’s right to terminate for good reason and appropriate severance pay
• Provision for full executive outplacement services at a firm of the leader’s choice.
• Company payment or reimbursement of executive expenses including trade association memberships, continuing education and other costs to maintain currency in the executive’s field
• Company payment as part of its executive retention (and not as compensation to the executive) costs of accounting, coaching and legal representation in employment negotiations.

HOW TO NEGOTIATE

While we recommend utilizing an attorney to help strategize what is possible, it is best that the attorney be kept behind the scenes.  The introduction of an attorney can set up an unnecessarily adversarial process.

There are exceptions that justify broader and more open use of the employment attorney. One exception is if the leader is going to be negotiating with a peer and that peer can get harsh during negotiations.  In the interests of preserving smooth working relationships in the future, the leader might say that the attorney is representing the leader so that the leader can focus attention on achieving company goals. Another exception is where the attorney was previously engaged in the original employment negotiations, and the employer is thus conditioned to expect such attorney would be involved again, which we have seen to be the case in other representations.  A further exception is a combination, where the executive begins the negotiations without the attorney present but as the negotiation is developed the executive’s attorney gets introduced into the situation

While this article describes the process of employment contract renegotiation, we don’t’ advice using that word.  Companies may want to take the position that it does not renegotiate employment contracts.  A renegotiation could set a precedent.  We recommend using a more neutral phrase like “reviewing a few details of the employment agreement in light of new information”  or even shorter “Updating employment terms to keep them current with new information and developments”.   For the equity piece of the negotiations, it’s often called “refreshing the equity piece” or “recalibrating equity to provide the desired current incentives.”  Such refreshing or “reloading” of equity normally is expected after down rounds or depressed market prices put executive options “under water”.  Hence, use of that term is expected in the employment context and useful here.  The leader may offer to agree to a confidentiality agreement stating that terms will not be discussed with others.

For this reason, it is suggested that leaders not confide to their colleagues that they intend to “review a few details….”  This is another reason why outside counsel is a good idea at this time.

TIME TO LEAVE?  (BE PREPARED)

Asking to reopen the employment contract negotiations will not endear leaders to CEOs or to Boards in the short term.  In the long term, such leaders might gain respect as tough negotiators and confident.

A renegotiation certainly implies that if the leader is flatly turned down then the leader will be looking outside the company for new opportunities.  We are not talking about a threat to quit but a commitment to look outside the company.

Hence, it is wise to commence at least initial exploration of alternatives both to know better your value in the current market, but to also be prepared if the effort at renegotiation, however phrased, leads you to look elsewhere.

Renegotiation of an employment contract should be done from a position of strength and a willingness to follow through.  Don’t play this game unless you are prepared.

Robert A. Adelson, Esq. is a corporate and tax attorney and partner at Engel & Schultz LLP, Boston, Massachusetts. www.engelschultz.com He represents executives in negotiations over employment terms, retention, equity, relocation and separation.  radelson@engelschultz.com

Laurence J. Stybel is co-founder of Stybel Peabody, a Lincolnshire International Company. www.stybelpeabody.com The firm helps companies manage leadership change when the stakes are high. lstybel@stybelpeabody.com

This article was originally published in the webzine AlwaysOn in two parts

“Let’s Make A Deal” on April 8, 2008 and “Deal-Or No Deal” on April 9, 2008.

© 2008 Robert A. Adelson and Laurence J. Stybel

Are you the first time founder of a successful startup company?

Are you an employee, investor or director in a successful startup still led by a first-time found CEO?

Is there concern that the skills needed for successful launch may not suffice to reach the next level of growth?

In early-stage companies, a founder’s success often speeds his or her replacement b a professional CEO to lead the next phase of growth of consolidation of existing growth.

The company’s success in meeting its first milestone plus its need for new capital to feed growth – to capitalize on opportunities present – often speeds a change at the top. Venture capital investors often condition funding on commitment to hire a professional CEO to lead the next phase of growth.

In mature companies, achieving revenue, profitability and market share assures the CEO’s income and viability. Paradoxically, the reverse is often true for startup founder CEOs.

The founder of CEO’s passion, vision and willingness to take risks, essential to the startup’s launch, are felt no longer needed to take the venture to the next stage. VCs now look to a proven ability to sustain infrastructure and organizational growth, to communicate, interface, harmonize and energize investors, directors, the media and other parties.

First-time founder CEOs may feel they can sustain growth, but investors in A and B rounds often require experience, a track record in scaling ventures to liquidity, before they will invest millions of dollars to fuel the next stage of growth.

The first-time founder seeking capital needs to recognize CEO succession is likely, perhaps inevitable, and take actions that benefit founder and company whether or not such succession occurs.

The first-time founder should build a strong board that includes independent, technology-savvy directors. Even as an investment comes and investors’ preferred stock terms exert a level of control, investors should not overload the board. It’s best to have an independent majority of industry representatives who can also empathize with the founder-CEO with a minority of VC members of the board who can offer input but not control the direction of the firm.

In taking investment, it’s wise to choose character over cash. Instead of focusing on valuation, spend time evaluating past investments in the field, experience and judgment. Even if the investors want a profession CEO, what input will the founder have? What will be the composition of the board? Founders should read the signs to be assured of mutual respect.

The first-time founder CEO also needs to protect himself – to assure legal and contractual protections for his post-CEO business position with regard to the company he directed.

Carry protection

Basic protections to seek with succession include these

• Minority shareholder protections including for information, against dilution and cast-out rights;
• Exercise rights over options, vesting of shares;
• Board representation or observer rights;
• Role in successor selection and transition;
• Post-employment paid consulting;
• Back licenses of technology, office support;
• Severance pay, post-termination benefits and coverages;
• Negotiation of noncompete, nonsolicitation, other restrictions

When to seek protections? As soon in this process as possible. When the Series A or Series B investors condition funding on hiring a successor CEO, the founder CEO then needs to set terms for his own protection.

Succession is a two-way street. The founder shows himself a “team player,” sharing with the investors the goal of making money. It’s about success not power. Yet, just as the founder shows his willingness to yield power to everyone’s financial gain, that’s the time the founder to achieve protection for his own stake in that financial gain.

For both founders and the company, careful planning including appropriate legal counsel improves the chances of the founder’s consent to succession and successful transition of the successor CEO.

Additionally, for the founder who built the company, it’s important to have your own counsel skilled in these matters. Having your own counsel focused on your interests and engaged early in the process improves your chances of avoiding the King Lear situation where all you built is owned by others and you, left with little recourse, to guide the enterprise or protect the investment of money, sweat and years of your life that went into creating the company that was once your baby.

Robert A. Adelson is a partner at Engel & Schultz, LLP of, Boston. A corporate and tax attorney for more than 25 years, Adelson represents early stage companies and entrepreneurs, executives and independent consultants.

The attorney and author of this article can be reached at (617) 951-9980 or radelson@engelschultz.com

With the stock market apparently recovering from the “dot-bomb” crash of 2000-02, companies are again using their rising stock to lure top executive talent. If it’s time for your family business to recruit key technical employees or senior executives from outside the family, how can you compete with these non-family firms? What can you offer prospective employees instead of stock or options?

As employee appetites for stock and options rise anew, it’s important for family businesses to meet the competition by offering their own form of equity — without actually transferring ownership. The good news is that today’s tax climate has made it easier for family firms to compete in the recruitment wars.

There are ways to give non-family executives a share in the rewards of ownership without actually transferring even one share of family business stock, ways and means that are discussed in this article.

Recruiting talent from outside the family

Your business may not be able to grow or face tougher competition if there are gaps in your family members’ knowledge, skills or experience. The best way to fill in the missing pieces is by hiring non-family employees.

Even if there is no gap, it may be wise to recruit a senior manager to help train and mentor the next generation in preparation for a leadership transition — someone who would also be available to step in if illness, death or disability strikes a core family member.

Unfortunately, a family business’s stability and long-term perspective, while attractive, don’t go far enough to lure potential recruits. A non-family executive may fear that nepotism and family loyalty may supercede sound business judgment. Hopefully, if you are seeking non-family talent, your company can allay these concerns by citing its record of putting growth of the business before the personal concerns of the family owners.

Offering a stake in the upside

But even if you can show a track record of growth and sound judgment, there is something else that might make non-family candidates skittish about joining your company: the perception that as non-family members, they won’t get to share in the benefits of their hard work.

Because most family business owners want to ensure that their company stays in the family, they don’t offer their non-family employees the opportunity to own stock. But there are ways to give non-family executives a share in the rewards of ownership without actually transferring even one share of family business stock. The three strategies below — particularly the phantom stock approach — are powerful weapons in your arsenal. Recent changes in federal tax and securities laws have made these options even more attractive.

Non-voting stock and ‘rabbi trusts’

One option is to institute a non-voting stock plan for key non-family employees. Non-voting shares are allowable in LLCs, C corporations and even S corporations. This structure provides for all the capital appreciation of normal shares and permits shareholders to take advantage of the record low 15% tax rate on capital gains and dividends. Under this arrangement, non-family executives have no voice in the company’s operations and strategic choices.

The second approach is a non-qualified deferred compensation plan, which can provide a secure future payout to a key executive. Taxation to the executive is deferred via a “rabbi trust,” a trust that is set aside for the employee but remains subject to company creditors. (It was first used for a New York rabbi and the nickname stuck.) The plan can include “golden handcuffs,” or vesting arrangements in which benefits are lost if the executive leaves the company. It can also include “bad boy” provisions, in which benefits are forfeited if the executive violates confidentiality or non-compete agreements or other company rules and restrictions during employment or post-termination.

Phantom stock: The most far-reaching solution

The third approach — a phantom stock plan, taxed in the same manner as deferred compensation — combines the first two. As the most far-reaching and innovative solution, it offers the family firm a real advantage.

Under a phantom stock plan, the company sets a share value benchmark at the time phantom shares are issued (phantom strike price). The phantom stock contract issued to the executive provides a vesting and redemption schedule as well as a method of future stock valuation. If the executive does a good job and the family business prospers, when redemption occurs the executive will be paid an amount equal to the value appreciation. That is, the executive is paid the difference between the share value on the date of “sale” (phantom stock redemption or payout date) and the original phantom strike price. This spread is the same kind of payout the executive would achieve if he or she had conventional stock options in a non-family business.

A family company’s phantom plan not only offers key employees a share in the company’s growth but also can do so on far better terms than plans offered by non-family competitors. Here’s how.

Sarbanes-Oxley and phantom stock liquidity

Many small public companies are going private or delisting their securities rather than face the heavy costs of compliance with provisions of the Sarbanes-Oxley Act, passed by Congress in response to several high-profile corporate scandals.

Executives at those companies will now have equity that is illiquid. This gives closely held family businesses a distinct advantage in recruitment. A well-designed phantom plan provides liquidity (i.e., an exit strategy) for executives that small-capital companies no longer offer.

Phantom capital gains vs. incentive stock options

A phantom stock plan can generate both phantom dividends and phantom capital gains by taking advantage of the deductions available in the tax law and sharing the benefit with key hires.

Under the 2003 tax law, capital gains are taxed at 15%, the lowest rate since 1933. Dividends also are taxed at 15%, the lowest rate since the introduction of the graduated income tax in 1916.

Plans that provide incentive stock options rarely allow executives to take advantage of capital gains or dividend tax treatment. Under today’s tax law, this is a huge lost opportunity.

2004 Election:  Opportunities in new tax proposals

At this writing it is unclear whether the next administration will be Republican or Democrat, but the beneficial use of phantom stock appears likely continued and even enhanced regardless of the outcome of November 2004 election.

If the President and Congress are re-elected, the thrust of GOP tax policy in 2005-09 will be to make permanent the recent Bush tax cuts, including those for capital gains, dividends and marginal rates scheduled to sunset during that ‘05-09 period, with an added drive to eliminate all tax on dividends.  If there is a change to Democratic rule, the Kerry program would roll back those same tax cuts for families earning over $200,000 and create new tax credit incentives for high-earning employers to hire new workers.

As said a phantom stock plan that generates phantom dividends and capital gains is well positioned for these currently planned 2005-09 GOP tax initiatives. However, the well-designed plan can cope and even utilize the Democrat policy shift.  The income deferral embedded in phantom plans allows beneficiaries to spread income.  So, the Kerry $200,000 family income safe harbor is obtainable.  Also, to the extent phantom stock aids hiring it gains the family business owner a tax credit, to benefit from tax changes.

A case example

An established family business (FamCo) has outgrown its current management and wants to recruit a chief operating officer from outside the family. The top candidate knows the industry, has managed a larger workforce with multiple offices and has proved his ability to take a company to a new level.

The current family CEO, at age 70, is looking toward retirement. The prospective COO, Bill Wilson, is 55 years old. Hiring this key player would bring new vigor to the company. The parties hope to see FamCo grow from its current valuation of $5 million to $10 million over the next decade.

FamCo offers Bill Wilson phantom stock that matches his annual salary of $200,000. During each year of a five-year contract, Wilson receives phantom stock units at a strike price of $5 per unit with the units vesting annually at 20% (half the vesting based on his remaining with FamCo and half based on achievement of his performance goals). In ten years, when Wilson retires, the company would again be valued and Wilson paid on the growth of his vested units, with a buyout over ten years.

Thus, if Wilson stays with FamCo 4 1/2 years, he accumulates 160,000 units. In that time, for example, if he achieves half his business targets, he’ll vest 60% of these units (vesting 80% based on four years’ tenure and 40% based on meeting half his targets). When he leaves after 4 1/2 years, 96,000 phantom stock units are vested (equivalent to almost 1% of the company) at the original $5 per unit. Wilson has no voting rights or rights to stock, but — assuming he doesn’t violate company covenants — he will receive a future payout for the units.

Now suppose that because of Wilson’s achievements over those 4 1/2 years, FamCo grows from a $5 million company to a $15 million company by 2014. The stock price (and, thus, the phantom unit value) grows to $15 per share. Under the plan, Wilson would be paid off at the spread between the $5 original strike price and the $15 current market price in 2014. With a $10 spread per unit, the payout on Wilson’s vested units would be $960,000, which would be paid over ten years with interest on the $960,000 note at the Wall Street Journal prime rate. With phantom income spread over 10-years at $96,000 per year, this plan is well designed to be taxed at lower rates even if Kerry plans for a roll-back in tax rates occurs for families earning over $200,000 per year. Under a phantom capital gains plan, the tax deductions generated by this payout would be shared between FamCo and Wilson to reduce his tax from 35% to 15%, thus achieving effective capital gains treatment on the payout, in line with low capital gains rate achieved by the Bush administration tax cuts.

This example works for any family business in any American industry, whether the business valuation is $5 million or $5 billion. Although the company must incur the cost of paying out phantom stock, it derives a much greater benefit from growth. These plans give family-owned companies the ability to recruit and retain key talent, which more than offsets the cost involved.

Robert A. Adelson, J.D., LL.M, a partner in the law firm of Engel & Schultz LLP in Boston, is a corporate and tax who represents closely held and family businesses and executive employees.

© 2004 Robert A. Adelson

______________________________________________________

Robert A. Adelson, Esq. can be reached at Engel & Schultz LLP,

265 Franklin Street, Boston MA 02110  radelson@engelschultz.com

(617) 951-9980 ext. 205

What a difference a year can make.  In May 2000, with the economy booming, there was a scarcity of people and plentiful well-paid jobs for all who wanted them.  Now, amid harder times and increased layoffs, much business related legal work today is focused on employee termination and severance arrangements.

In this changed environment, corporate attorneys should be paying increased attention to the details of employment termination to avoid legal surprises that can be quite costly.  For companies that may be considering layoffs, it is wise to review the company manual and employment contracts on the issue of termination.

Company attorneys should review employee manuals and assure that all offer letters say expressly in bold type that employment is at will.  They should also say that employment is contingent on the signing of the company nondisclosure or noncompete agreement.

If exceptions are made for important hires, the exceptions must be documented in an offer letter or employment agreement and should be clearly indentified as exceptions justified by business needs.  Employees, too, should seek clarity if they want a commitment in length of term, responsibilities of position, level of staff or support of their position.

Just like no one wants to write a will and contemplate death, employers and employees may not want to contemplate termination issues as the optimistic beginning stage of an employment relationship.  However, business attorneys need to raise the issue of “employment death.”  Advance planning is a must.

Business attorneys representing employees or executives need to negotiate severance terms coming in, including outplacement, continuation of benefits, extensions on option exercise and waiver of noncompete agreements.

In a down economy, an employee’s attorney will need to temper goals by the client’s need to take the job.

Employers may not terminate based on age, race, sex, ethnicity, sexual orientation and/or disability.  If discrimination can be shown through the employer’s statements or course of conducts, damages for wrongful termination may arise.

Given the risks of damages, award of attorneys’ fees and the time and money wasted in employment litigation, it is wise to review with an attorney the programs your company has in place, in the event of terminations.

© 2001 Robert A. Adelson and Emilie F. Athanasoulis

_____________________________________________________________

More information on legal issues in employment termination or severance, contact –

Robert A. Adelson, Esq.

Engel & Schultz, LLP

265 Franklin Street, Suite 1801

Boston, MA 02110

Telephone: 617-951-9980

E-mail: radelson@engelschultz.com

By Allan A. Kennedy

Consider, for example, the case of Robert Adelson.  Adelson was a young corporate lawyer in his native Boston in the early 1990s.  Struggling to build a practice, he spent a good deal of his time calling on the high-tech companies that had sprung up in the Boston suburbs, asking them to consider his firm for their next major piece of corporate legal work.  One day in 1992, one of the executives he was calling on in a software company pulled him aside after the meeting was over and sought his counsel on a personal matter.  The executive was about to take a job with a rival firm and wondered if Adelson could represent him in the negotiations with his prospective employer.  Adelson, who was well grounded in tax issues, readily agreed.  After he had successfully completed this initial assignment, Adelson got a call from an executive in a biotech firm who was similarly changing jobs.  Then he heard from another and another.  Although Adelson’s fees may not be as high as Bachelder’s and his client list not quite so famous in the business press (his clients earn upward of $70,000 a year in base salary, with most comfortably in the six figure area), he has created a thriving and lucrative practice in one of the fastest-growing areas of corporate law.  Today Adelson represents around twenty or thirty executives a year involved in job switches and another twenty or so companies that have come to respect his expertise at the negotiating table.  One of the beauties of the practices is that it encourages repeat business with little or no effort on Adelson’s part.  An executive pleased with the first packaged Adelson negotiated for him is almost certain to return to him the next time a job switch opportunity appears.  With turnover rates in executive ranks nearing 30 percent, Adelson’s future is secure.

Adelson is not alone.  Every major law firm in Boston (and every major city across America) and many smaller firms as well have lawyers representing clients negotiating for new jobs.  Executive search and human resource consulting firms and also getting on the trend.  There is now even a Web site (http://www.salarymaster.com) that offers to take on all comers involved in computer-related professions, and as a part of its service it provides links to other Web sites that give details of wages paid for various kinds of technical jobs across the country.

© 2000 Allan A. Kennedy

___________________________________________________

Robert A. Adelson, Esq. the attorney mentioned in the above book excerpt, continues to represent senior executives, including CEOs, COOs, CFOs, Presidents, Vice Presidents and directors.  If you are an executive in need of representation, whether negotiating a new position, renegotiating employment terms, or dealing with severance, termination or relocation,

Mr. Adelson can be reached at his Boston law firm, Engel & Schultz, LLP, radelson@engelschultz.com ♦ 617-951-9980 ext 205

In the volatile biotechnology, medical device and pharmaceutical industries, executive and technical talent is critical to success  and ever harder to maintain.  Are you doing all you can to attract and retain talent for your company?

A prized hire says “show me the money” and you don’t have it.  If you had the recruit, you could grow and make the money.  Is there a way out of the box?

Key executives or technical people leave when you can’t keep pace with industry pay levels.  How do you keep the team in place and motivated?  Can you cut pay-driven turn-over?

This article offers techniques for incentives and pay raises to beat the competition, build your company, not break the bank and even save money.  These techniques deliver  (1) big-time  dollar value to the employee, (2) lower tax cost than normal bonus pay,  (3) greater perceived value to employee,  (4)  no net cash cost to company and  (5) actual cash savings.

Use a Signing Bonus

Technical and executive  hires often resist switching jobs because of vesting benefits, expected bonuses, and other “Golden Handcuffs.”   A  signing bonus can be your “Golden Key” to unlock the door to hiring.

In 1996, Alex Mandl left his job as chief operating officer of AT&T to become CEO of early stage telecommunications carrier Teligent with a $25 million signing bonus to compensate Mandl for what he lost leaving AT&T.

When cash like that is out of the question, your golden key can be fashioned in creative use of company equity to serve the same purpose.  An Equity-based signing bonus can equally cement the bond with your company and compensate new hires for risks taken in leaving a job.

What you pay up front can vary, depending on your need and the immediate value the person brings, as well as what the person gives up to join you.  An equity based bonus  can take many forms – qualified or non-qualified stock options, restricted stock, or phantom stock.

Meaningful Equity Benefits Employee and Company

The offer of meaningful equity – stock, options or phantom stock in your firm – can set your company  apart in the battle to build your team.

To enhance and “sell” your equity, the company can offer a package of rights to deliver a real equity stake to key employees.  This can  include anti-dilution protection of the value of employee’s equity against future corporate changes and future issues of stock to others. Cash-out protections can allow the employee an “exit strategy” to realize cash value on shares where there is no prospect of an IPO or sale of the company.  Alternatively, change of control protections accelerate vesting of shares when the company is sold and employee’s position may be at risk.  Post-termination protections  allow stock concessions to lesson fear of termination when most employment is at will.

Employee equity also benefits the company.   Equity for pay preserves cash.  It can also make money from tax deductions as explained below.  Equity helps in other ways – it rewards employees for their loyalty, their individual project achievements and the firm’s success and to bring employees an entrepreneurial mindset.  It can also backstop or serve as consideration for non-compete and confidentiality agreements which are often signed at the time equity is offered..

Use Tax-favored Equity Boosts Pay

To leverage the firms future payout to employees, you should structure equity so it’s taxed as low as possible.  This structuring will boost the technical and executive take-home pay.

Because pay increases are taxed at the person’s highest marginal rate, the ability to cut that tax bite and increase the take home pay is a powerful tool to show the equity based signing bonus or pay raise is more valuable to the employee.        Here, the rule of thumb is stock options are better for high-value equity and restricted stock is better for low-value equity.

Founders Shares  Attract Key People

For senior recruits, technical or executive, you want to offer more to beat the competition.   Fro key people, non-qualified options or restricted stock  can be offered in lieu of cash – to deliver immediate value with a strike price much less than current fair market value.

By offering stock or options at a nominal price, the recruit has a built-in value on day one. Yet by using its stock the company has avoided cash cost.  The company will only have to pay out if a future stock buy-back is offered.  Yet, by that date (several year later) the company may be out of the box – in a cash position to pay.

Stock offers key advantages that make equity more valuable to employees than cash:

• Pre-IPO stock is valued at discount, and all stock is awarded without brokerage charge;
• Stock offers the potential for considerable appreciation that cash lacks;
• Appreciation is taxable at lower capital gains rates of 20%, with no withholding;
• Stock offers the potential for future roll-over so that tax may be deferred indefinitely.

The tax-free roll-over is new from the 1997 Tax Law – to potentially allow employees who receive stock from C corporation software companies the right to sell these shares and roll-over profits into new ventures, with tax deferred until the final sale of shares.

Shares and Tax Gross-Up Save Money

In addition, because the issue of founders shares is deductible, the company can save money that would have gone to taxes by using stock for pay.  The tax windfall can also be used creatively to enhance efforts to recruit or retain key people.  This is done by sharing the company’s tax windfall with employees.

This sharing in the form of stock appreciation rights or tax gross-up can have the effect of reducing effective tax restricted stock from the 39.6% ordinary income rate to 20% capital gains rate or even lower.  This is also useful in family businesses or professional corporation which cannot offer stock or options but must use phantom stock instead.

Employee-Company Win-Win:   Example

Problem: BioCo. (BC) has 100m to spend.  Smith seeks 150m pay.

Solution: BC gives Smith 100m cash, 50m stock, 34% gross-up.

Effects: For Smith: He has 170m perceived gross value – he’s happy.

For BC: It spent 94k cash after-tax, got Smith &  saved $$.

Analysis: 50m Stock deductible to BC, @34%, it saves $16m.

16m gross up cuts Smith’s taxes @39.6% on stock to 10m.

Stock after-tax value 40m. Normally takes 70m to net 40m.

Both stock & tax gross-up deducted by BC, net savings 6m.

The table  above shows an example of a biotechnology company, BioCo, that uses equity and the resulting tax deduction to save itself money but still offer what appears to be a large premium to land Mr. Smith, the technical or executive hire it was recruiting.    In this example, the company can only offer $100,000 but employee Smith wants $150,000.  By creative use of founders stock and tax gross-up, the company can offer a premium package worth $170,000 but at a cash cost to the company of only $94,000.

However, tax advice needs to ensure the right mix of equity, including restricted stock, ISOs, non-qualified options, Stock Appreciation Rights, or Phantom Stock.   In each case, plans must be carefully structured to avoid ruinous “tax surprises”. Accounting advice is also important to balance the benefits of wealth transfer in below market stock and options, SARs  and tax gross-up with potential hit to earnings on financial statements.   Clearly, these techniques are not for everyone.  Where a company is in play and its PE ratio critical, accounting concerns will govern.  However, if growth is the priority, cash savings important, and building the team critical, these merit close consideration.

Robert A. Adelson, J.D., LL.M. is a Boston corporate and tax attorney.  He  represents companies and individuals in the bioltechnology and medical device fields across the U.S. on employment, stock, options, relocation, severance, executive, employee compensation issues and in consulting, sponsored research and alliance contracting, and on mergers and acquisitions.

Since 2004, Robert Adelson has been a partner at Engel & Schultz LLP.  He can be reached at 617-951-9980 or  radelson@engelschultz.com

Copyright © 1999 Robert A. Adelson.

General Rule:

During employment, officers, directors and senior employees owe a fiduciary duty  to protect the interest of the company they serve.  All employees must maintain secrets material to a  business,  and no employee may steal customers or assets while still employed by a  company.  After employment ends, an employee is generally free to compete. Although post-                 employment competition restraints are “scrutinized  carefully”, courts in Massachusetts (as in many other states) uphold such agreements to the extent they protect legitimate interest of  the employer, do not impose an unreasonable burden on the employee, and are not injurious  to the public.  Courts may also act to limit duration or scope of agreements if unreasonable.

1.         What is an Employee Non-compete?

Non-compete in the Galaxy of Employee Restrictive Covenants

1.1       NDAs /Confidentiality

• Non-Disclosure / Non-Use

• Trade Secrets

• Proprietary Information

1.2       Assignment of Inventions

• “Work for Hire”

• Assignment of IP Rights

• Cooperation

1.3       Non-Solicitations

• Customers / Suppliers

• Prospects

• Co-workers

1.4       Employment restrictions

• Not to work for competitor

• Not to do competing work

• Defining Competing work/ companies

2.         How Restrictive is it?

Coverage and Scope of Employee Non-compete Agreements

2.1       Duration – during / after employment

2.2       Field of coverage – employer business

2.3       Field of coverage – employee activity

2.4       Geography

2.5       Exceptions

3.         Whose ox is gored here?

Stakes and Interests in Non-compete for different Parties

3.1       Employer Interest – training, access, secrets, corp. opportunities/ “good will”

3.2       Employee Interest – prior knowledge, contacts, reputation

3.3       Public Policies involved – Employee freedom vs. Employer proprietary rights

4.         When did it happen?

Effect of Timing when Non-compete arises in Employment relationship

4.1       At Hiring – employee reliance in accepting position

4.2       Mid-Term / at promotion

4.3       On Termination

5.         What kind of Work?

Effect of Type of Employment relationship

5.1       Full-time /  Part-time

5.2       Consulting / Independent Contractor

5.3       How long was employee on the job

6.         Show me the money!

Effect of Cash and Non-cash Considerations paid for Non-compete

6.1       Signing Bonus

6.2       Cash Bonus, Stock or Options

6.3       Severance Pay

6.4       Return or loss of Benefits

7.         Where’s it say that?

Documentation to effect Employment Non-competes

7.1       Employee Offer Letter/ Term Sheet

7.2       Employment Agreement;  Consulting or Service Agreement

7.3       Separate Non-disclosure /Proprietary Inventions/ Non-compete agreement

7.4       Trade secret/No conflict and other company policies – follow through

7.5       Exit Interview; severance, termination or separation agreement

7.6       No Documentation / operation of law

7.8       Severability of Terms/ Judicial Blue Pencil

7.9       Varied Enforcement by Jurisdiction

8.         Is there more than a job going on here?

Effect of Non-competes arising from Employment AND the Sale of business,

Investment in a business, and other Non-employment Motivations

8.1       Founder’s Employment

8.2       Retention Covenants

8.3       Other Hybrid Covenants

RAA156:\lorman.outline

R.Adelson – 8/14/98

____________________________________________________________________

**  This outline was for the presentation by Attorney Robert Adelson as part of a 4-hour seminar course for attorneys, accountants and other professionals, for continuing professional education credit, sponsored by Lorman Educational Services.

Questions on this presentation or the subjects covered,  including any questions byemployees or  executives regarding non-compete, non-solicitation or other restrictive covenants or other issues of employment or employment termination, may be directed to the author and speaker at his current law firm, as follows:

Robert A. Adelson, Esq.

Engel & Schultz, LLP

265 Franklin Street, Suite 1801

Boston, MA 02110

Tel:  (617) 951-9980 ext 205

E-mail:  radelson@engelschultz.com