A common topic of negotiation in M&A transactions is how to treat performance-vesting equity awards for which the relevant performance period is not yet completed as of the closing of the deal. The target company may have outstanding performance shares, performance-based restricted stock units (PSUs), or other awards that vest based on the achievement of certain companywide or business unit–wide financial metrics over a certain performance period.
Many times this performance period can span several years and the criteria may not be measurable following closing. Further, the buyer may want to replace the preclosing performance-vesting terms with completely different vesting terms going forward that better align with the buyer’s priorities and business realities.
What Do the Documents Permit?
The first step in this analysis is for counsel to review the governing documents, including the equity plan, grant agreements, and any employment contracts or other arrangements that set forth the terms of the awards to determine what is contractually permitted. Do they provide for specific treatment of performance metrics? Do they include broad discretionary language for the board or compensation committee? Do they provide for acceleration and, if so, how is acceleration measured—at target or maximum level?
Key Decision Points
The analysis for how best to treat performance-vesting awards in connection with a corporate transaction can be multifaceted and will vary deal by deal depending on the facts and circumstances. Listed below are some key decision points to consider when conducting this analysis:
- Should unvested awards be accelerated at closing? If so, should all such awards be accelerated or should only a prorated portion be accelerated based on how much time is left in the performance period? If only a portion is accelerated, should/can the remaining awards be substituted with new awards, or canceled for no consideration?
- Can the existing performance goals be modified or adjusted to continue to apply postclosing? If not, should the existing performance goals be replaced with new performance goals specific to the buyer or combined entity, or should the performance-vesting criteria be eliminated with only time-vesting terms applying after closing? What does the plan or award agreements permit? Do you need participant consent?
- How is the performance level measured? Is it based on “target” or “maximum” level? What impact do other events such as termination of employment have on the measurement? If at closing PSUs will be accelerated and cashed out, or substituted with time-vested awards, consider whether the number of PSUs to be settled or substituted should be based on target-level performance, maximum-level performance, or the greater of actual performance to date and target-level performance. When assessing these alternatives, the parties should consider the level of actual performance that is realistically expected to be achieved as of the closing date.
- If measuring actual performance, consider whether to (1) measure performance through the closing date or through some other benchmark date (e.g., the end of the most recent fiscal quarter), (2) adjust the goals to account for the partial performance period or leave the goals unadjusted but with actual performance through the closing date (or other benchmark date) interpolated through the end of the performance period, and/or (3) build in a floor of “target” (i.e., utilize actual performance, except that target-level performance will be assumed in the event that actual performance falls below target).
- The awards may be subject to “double-trigger” vesting terms, pursuant to which vesting would accelerate upon a postclosing termination of the awardee’s services by the company without “cause” or by the awardee for “good reason.” If such double-trigger protection is to remain in effect postclosing, the buyer should assess whether the “good reason” concept is appropriately tailored and should revise any overbroad “good reason” definitions accordingly. For example, the buyer would not want an awardee to be able to resign for “good reason” and receive accelerated vesting solely as a result of the transaction and without any corresponding diminution in role or compensation.
- If awardees have any conceivable argument that the treatment of awards in connection with the deal is not permitted under the plan document, grant agreements, or other governing documents, then the buyer should consider whether to require consent from the participant.
How We Can Help
Morgan Lewis lawyers regularly advise clients on evaluating equity award treatment approaches in M&A transactions, including negotiating the treatment of awards still subject to performance-vesting conditions. We recognize that there is no universal solution for outstanding performance-vesting awards in the M&A context.
In light of this, we utilize our extensive background in this area to provide clients with practical approaches that enhance our clients’ economic outcomes, facilitate seamless postclosing transitions, and ensure legal compliance in all respects. Please contact the authors of this blog post or your Morgan Lewis contacts with any questions about the performance-vesting award treatment strategies discussed above.