Reviewing Executive Compensation as Due Diligence in Acquiring a U.S. Company

As a company conducts due diligence as part of its plans to acquire a U.S. company, it should review the executive compensation of the company being acquired. This review not only allows a better understanding of the compensation structure but may uncover any liabilities or compliance issues that might affect the purchase price in the transaction. Compensation information is necessary to properly draft appropriate transaction documents and create a comprehensive plan for integrating compensation structures as one company acquires the other.

Materials to Review

Although the available materials to review will depend on whether the target company is public or private, typical materials that make up the scope of an executive compensation review include the following:

  • Employment agreements, offer letters, and other individual compensation agreements;
  • Equity incentive plans and awards;
  • Cash bonuses and other incentives;
  • Severance plans;
  • Retention, transaction, change in control, and similar types of incentives;
  • Nonqualified deferred compensation arrangements; and
  • Perquisite or other enhanced benefit arrangements.

The type or nature of the transaction may also affect the scope of the executive compensation review. For instance, if the merger involves only a single department or arm of a much larger business, the executive compensation structure may not automatically transfer to the acquiring company as part of the transaction. Therefore, the degree of necessary due diligence concerning executive compensation may be much less than that needed to acquire an entire company.

Focus of Review

In carrying out due diligence as to executive compensation, the priority is to understand the executive compensation program and any individual compensation programs of the target company. This process allows the reviewing company to identify tax, security, or other legal compliance issues that could affect the purchase price or other transaction terms. It also permits the company to assess retention issues, determine incentives, and assist in integrating one company’s compensation scheme with the other.

For example, the reviewing company must determine whether the transaction will trigger compensation or benefit payment requirements, such as bonuses, severance obligations, or accelerated vesting or settlement of outstanding equity awards. These compensation requirements often occur with a qualifying termination of employment within a specified period in relation to the transaction. Additionally, to the extent that the transaction triggers compensation requirements, the company must determine whether the payments or benefits payable are subject to excise taxes and loss of the corporate tax deduction associated with “golden parachute payments” under the Internal Revenue Code Sections 280G and 4999.

One legal compliance issue that might arise is a target company’s failure to comply with a compensation agreement or other compensation-related contract, which may necessitate corrective action. Another area of concern is the target company’s failure to comply with applicable tax laws. A common issue of concern is Internal Revenue Code Section 409A, which applies to including deferred compensation under nonqualified deferred compensation plans in gross income. Compliance with this section is particularly crucial due to the potential for significant penalties that may result. Finally, compliance with securities laws, at both the federal and state levels, is also of interest during an executive compensation review.

The due diligence process also allows the acquiring company to prepare for the integration of executive compensation structures. The company can decide whether any changes are necessary to integrate the two systems successfully. Some changes may require the consent of employees or an event to trigger the “good reason” provisions in employment agreements that would permit voluntary employment resignations with accompanying severance packages. Some transactions may also provide for a continuation of existing compensation levels for target company employees for a period following their closing, and the company may need to assess whether that arrangement is feasible or possible.

HBL has experience in all areas of benefits and employment law, offering a comprehensive solution to all your business benefits and HR/employment needs. We help ensure you are in compliance with the complex requirements of ERISA and the IRS code, as well as those laws that impact you and your employees. Together, we reduce your exposure to potential legal or financial penalties. Learn more by calling 470-571-1007.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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