The purpose of this post is to discuss select design considerations when structuring change-in-control bonus arrangements for key employees.

• Identify the Key Employees.  The first step is to identify which key employees should participate and at what approximate values, focusing on those key employees that have the ability to increase shareholder value.  Questions to ask include: (i) do any of the key employees have the ability to increase the value of the target company if he or she remained employed through or after consummation of the transaction? (ii) if contingent consideration is part of the purchase price (e.g., earn-outs to shareholders), do any of the key employees remaining with the buyer after the transaction have the ability to increase the value of such contingent consideration?
• Funding Trigger.  In situations where a change-in-control pay is being designed at a time when the buyer has not yet been identified, consider what type of transaction should trigger the payout.  For example, should a sale of 50% or more of the company’s total voting power trigger funding?  If yes, then be sure to design the documents to address what happens to the remaining compensatory interest (e.g., if 5% of the sale proceeds goes to Employee Mary and only 70% of the company is sold in the transaction with the selling shareholders continuing to hold the remaining 30%, then does Employee Mary’s still receive 5% as though 100% was sold?  Or is her interest reduced pro rata with a 0% interest in the remainder that is held by the shareholders?  Or does she continue to hold a 5% interest in the remaining 30% to cover the situation where the remainder is sold in the future?).  As another example, should the change-in-control transaction include any monetization of the company’s intellectual property rights that would result in payments to the shareholders (i.e., the company licenses its IP, becomes a royalty company and has no change-in-control transaction).
• Considering Creating a Pool.  Frequently the change-in-control bonus arrangement is designed at a time when the selling shareholders have not yet identified all of the participating key employees.  This situation can be resolved by creating a pool of dollars denominated as a fixed dollar amount or percentage of the sale proceeds.  A benefit of the pool concept is that it can be denominated in units, thus creating a self-contained pool that can be diluted as key employees are identified to participate in the future.  An example of a basic pool formula is: [(pool value/total number of units issued and outstanding immediately prior to consummation of the sale transaction) x number of units awarded to the key employee].  The following is an example of an advanced unit concept where the pool is a percentage of the sale proceeds:

Key Employee’s Interest = [{A-(B+C) x D}/E] x F

• Sale Proceeds.  Should the value of the award (or the value of the pool) fluctuate based upon the value of the sale transaction proceeds?  Should the value of the award (or the value of the pool) be tied to only sale proceeds that the selling shareholders receive, or should such value also include contingent consideration such as earn-outs received by the selling shareholders?
• Vesting Conditions.  The most common vesting condition is requiring the key employee to be present on the payment date.  And in situations where the buyer has negotiated a portion of the transaction pay to be paid to the key employee after consummation of the sale transaction (i.e., in order to incentivize the key employee to remain enthusiastically employed with the buyer), then it is most common to require accelerated payout if the key employee’s employment with the buyer is terminated by the key employee for Good Reason or by the buyer without Cause.

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