WARRANTS, OPTIONS & OTHER INCENTIVES IN BUSINESS TRANSACTIONS First Run Broadcast: February 9, 2015 Live Replay: August 7, 2015 1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes) Equity warrants and options are incentives or kickers in business transactions or operations. Each instrument providers the holder participate in the financial upside of the company on generally favorable terms. Warrants allow equity investors or subordinated lenders to potentially increase their overall risk-adjusted return. Options are compensatory in nature, allowing the company to provide employees and service-providers financial participation in the issuer s growth without cash expenditures. But these are very complicated instruments and the two can be adverse to each other. If options are exercised by employees and others, it dilutes the value the warrants unless the warrants have anti-dilution provisions. Warrants also come along with a multitude of other protective provisions from voting to liquidity rights that options do not. This program will provide you with a practical guide to drafting the essential terms of equity warrants and options, and their underlying plans and other documents. Drafting the essential provisions of equity warrants and options, plans and documents Differences between warrants and options, and circumstances in which they are best used or avoided Defining conversion ratios and establishing post-conversion rights Forms of anti-dilution provisions for warrants Voting and information rights for warrants, including director appointment or board observer rights Defining liquidity rights of warrants rights of first refusal, tag-along, change of control and drag-along issues Drafting stock option plans and avoiding traps Review of tax consequences of warrants and options for issuers and holders Speakers: Matthew Hyde is an attorney with Cooley, LLP, where he specializes in representing emerging growth companies and venture or private equity investors in various transactions including private and public financings, mergers and acquisitions and cross-border transactions across a variety of industries including clean technology, software and internet, consumer products, and communications. In addition, he serves as outside general counsel to several startup companies and counsels their management teams and boards of directors on general corporate matters and related governance issues. Mr. Hyde received his B.S. from the United States Naval Academy and his J.D. from the University of California, Los Angeles School of Law. Christopher Kiyan is an attorney with Cooley, LLP, where his practice focuses on the representation of high growth companies, ranging from the idea-stage startup to the established later-stage business, and the venture capital and private equity investors that invest in high growth companies. He regularly represents his clients in a wide range of equity and debt financings and mergers and acquisitions across a broad spectrum of technology industries. Mr. Kiyan received his B.S., cum laude, from the University of California, Los Angeles and his J.D. from Boston University School of Law.
VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # E-Mail Address Warrants, Options & Other Incentives in Business Transactions Teleseminar August 7, 2015 1:00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER July 31, 2015 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:
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Warrants, Options & Other Incentives in Business Transactions Mike Baker (720) 566-4029 mbaker@cooley.com Matt Hyde (720) 566-4241 mhyde@cooley.com attorney advertisement 2014 Cooley LLP 3175 Hanover Street, Palo Alto, CA 94304 The content of this packet is an introduction to Cooley LLP s capabilities and is not intended, by itself, to provide legal advice or create an attorney-client relationship. Prior results do not guarantee future outcome.
Overview Why Do We Give Equity Incentives? Types of Incentives and their Attributes Corporations Pass Through Entities Treatment of Equity Incentives in Mergers & Acquisitions Tax Considerations Practice Tips/Things to Keep in Mind 2
3 Why do we use equity incentives in transactions?
Why Grant Equity Incentives? Cash Poor Grants to employees Other service providers Market expectations Provide Upside Retain Control No vote until exercise Tax Benefits 4
5 Types of Equity Incentives and Their Attributes
Corporations vs. Pass Through Entities Types of Equity Incentives Available for Issuance in Corporations Stock Options Restricted Stock Stock Appreciation Rights Restricted Stock Units (RSUs) Types of Equity Incentives Available for Issuance in Entities taxed as Partnerships Profits Interests (or Carry ) Options Restricted Units Warrants 6
What is a stock option? A stock option is the right to buy a specified number of shares of stock at a set price during a specified period of time 7
Stock Option Basics Options (and Warrants) vs Other Types of Equity Benefits: Greater control over timing of investment Greater control over timing of taxation People seem to understand options Potential Downside: May result in partial or total taxation at ordinary income rates 8
What types of stock options are there? Types of Stock Options Incentive Stock Options ( ISOs ) Potential for favorable tax treatment Described in Section 422 of the Internal Revenue Code Requirements The tax benefits of ISOs are only relevant to individuals subject to U.S. taxation. Awards made to foreign individuals will generally be nonstatutory stock options. Nonstatutory Stock Options or Nonqualified Stock Options ( NSOs ) Any stock options that are not ISOs There is no corporate, securities, or other non-tax difference between ISOs and NSOs only tax differences 9
What types of stock options are there? ISO Plan Requirements Specify maximum number of shares issuable as ISOs Specify class(es) of employee eligible Approved by stockholders Maximum 10-year duration of plan Option Requirements Employee status Exercise price no less than 100% FMV on date of grant Maximum 10-year term of option Non-transferability of option Designated as ISO (or at least not designated as an NSO) $100,000 Annual Limitation on Exercisability of ISOs Special rules for 10% stockholders 10
Stock Option Basics Exercise Purchase of some or all of the shares Types Regular exercise Early exercise Net Exercise Exercise Price Consideration paid to exercise the option Typically 100% FMV on grant date Requirement for ISOs Potential adverse tax consequences for discount options under Section 409A 11
What is a warrant? A warrant is the right to buy a specified number of shares of stock (either common stock or preferred stock) at a set price during a specified period of time. Types of Warrants discount / penny warrant priced warrant (no FMV requirement) Vesting/Exercise Periods Time-based Milestone-based 5-,7- and 10 year warrants Features Issued to persons or entities Anti-dilution/Exercise Price Adjustments Special rights Early termination 12
13 Treatment of Options and Warrants in M&A
Treatment of Options and Warrants In M&A Transactions Options Cash Out Acceleration (single vs. double trigger) Cancellation Rollover Warrants Automatic exercise Terminate immediately prior transaction 14
15 Tax Considerations
Most Frequent Tax Considerations ISO vs. NSO Exercise of Unvested ISOs Taxable on Grant Taxable on Sale (to the extent there is gain) Capital Gains vs. Ordinary Income Regular Exercise vs. Early Exercise of Options 83(b) Elections 16
Practice Tips & Things to Keep In Mind 17
Remember The securities exemption Rule 701 only covers equity grants to natural persons ISOs only for employees You can backdate vesting start date, but never grant date Options must be granted at FMV and approved by the Board Single vs. Double Trigger Matters Substance over Form for compensatory warrants If exercising early, consider NSOs Consider OID issues when warrants are issued as note financing kickers 18
Thank You! Warrants, Options & Other Incentives in Business Transactions Mike Baker Matt Hyde mbaker@cooley.com mhyde@cooley.com (720) 566-4029 (720) 566-4241