The following Q&A explains a few VBP design features that can help meet the needs and desires of owners and key talent in private companies headed toward a change in control.
Q: Can VBPs be crafted to share upside value only after owners get a return on their capital?
A: Yes, owners can set a floor below which the plan does not pay out. At TradeX One, for example, the owners set the plan’s floor at $10 million.
Q: If several executives leave prior to a change in control, will the remaining executives receive a windfall?
A: No, the separation of executives does not automatically benefit the remaining executives. VBPs are based on plan units, and the value to any executive is based on his or her awarded units divided by total authorized plan units. Further, there is no obligation to award all the units under the plan.
Q: Do the sharply-defined value bands trigger some game playing by the owners to either get above or below a value band?
A: Some owners are comfortable with a few bands and big incentive targets (a kicker). For others, the plan can include more bands at smaller intervals or, in some situations, a smooth line, such as higher value band award for every $1 million in transaction price.
Q: Many deals have large escrow and earnouts that are paid long after the sale. How are those handled?
A: Typically, plans require executives to remain employed by the acquirer to receive a share of escrow and future earnouts. Executives who remain are trued-up for their value share after specified earnout and escrow payments are received.
Q: What if the company is not sold because owners decide not to sell or no buyer materializes?
A: Because VBPs are intended to be developed outside the rigid designs of 409A applicable to nonqualified deferred compensation plans, owners can provide discretionary payments to plan participants at a time and in a form that suits their situation and sense of fairness. As circumstances change, the plan can be modified or replaced to reflect current realities with few or no tax implications.
Q: Can a portion of plan value be paid to executives only after a service or performance period following change in control?
A: With careful design, a portion of plan benefits can be subject to a “golden handcuff” while keeping the plan outside of 409A and managing the tax implications.