Section 409A
Real World Recommendations from
Experts in the Field
Agenda
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Introductions
General Scope of IRC 409A
409A Compliance & Equity Compensation
Valuation Methodology
Frequently Asked 409A Questions
Audience Questions
Introductions
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Elliot Williams (Moderator)
President
Mirus Capital Advisors
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Elliot Williams joined Mirus in 1991, has been a Partner since 1997, and
has served as President of the firm since 2000. Mr. Williams has worked
on more than 60 advisory engagements for clients – negotiating,
structuring, valuing and closing mergers, acquisitions, and financings.
An expert on the Business Services Industry, over his career Mr.
Williams has managed engagements in business process outsourcing,
hosting, systems integration, staff augmentation, and trade show
management. He has also represented clients in other industries
including software, telecommunications, packaging and specialty
coatings. Mr. Williams currently serves as the President of the
Association for Corporate Growth, as an advisor to the boards of
several entrepreneurial companies, and as an active member of the
Boston Chamber of Commerce and the Alliance of Merger and
Acquisition Advisors.
Mr. Williams earned a B.S. in Business Administration from Babson
College and holds Series 7 and 63 NASD certifications.
Introductions
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Bas van der Brugge (Finance/Valuations)
Senior Associate
Mirus Capital Advisors
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Bas van der Brugge is a Senior Associate with Mirus, where he
conducts Section 409As for clients. Additionally, he has participated in
over a dozen M&A engagements at Mirus. Prior to joining Mirus, Bas
was an associate and member of the Corporate Finance and Strategy
Practice at McKinsey & Company in Amsterdam. While at McKinsey,
Bas worked with the senior management of leading European and
Asian companies on market analyses, company and project valuations,
and to advise and structure joint ventures and strategic alliances for
acquisitions and divestitures. He has worked extensively in the
software, services, telecommunications, and transportation industries.
Bas graduated with a Master of Science degree in Financial
Econometrics from Erasmus University in Rotterdam, the Netherlands.
In addition to being a CFA charter holder, he holds Series 7 and 63
certifications from the NASD.
Introductions
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Andrew Liazos (Legal)
Partner
McDermott Will & Emery LLP - Boston
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Andrew Liazos heads the Firm’s executive compensation practice in the
law firm of McDermott Will & Emery LLP.
Andrew is ranked as a leading executive compensation and employee
benefits lawyer by Chambers USA – America’s Leading Lawyers for
Business.
Andrew is a faculty member of the American Law Institute-American Bar
Association, a John S. Nolan Fellow of the ABA’s Section of Taxation
and a frequent commenter on IRS proposed regulations and guidance.
Mr. Liazos is a graduate of the University of Massachusetts and Suffolk
University Law School.
Introductions
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Alex Lifson (Tax & Accounting)
Director
Deloitte Tax LLP
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Alex Lifson is a Director in the Global Employment Services
practice at Deloitte. Alex assists clients with numerous issues
related to executive compensation and employee benefits. His
practice is focused on designing and implementing equity
compensation strategies, executive compensation issues in
mergers and acquisitions, various retirement and incentive
programs, deferred compensation arrangements and
performance based compensation.
Mr. Lifson holds a B.A. in Economics from Bates College, an
M.B.A. from Boston University and an M.S. in Taxation from
Northeastern University.
Agenda
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Introductions
General Scope of IRC 409A
409A Compliance and Equity
Compensation
Valuation Methodology
Frequently Asked 409A Questions
Audience Questions
What is IRC 409A?
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Congress enacted 409A as part of the American Jobs
Creation Act of 2004 in response to perceived abusive
compensation practices
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IRC 409A applies to “non-qualified deferred
compensation” (NQDC)
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Restricting the timing of deferral elections
Limiting permissible payment events
Restricting changes to time and form of payments
Restricting certain funding vehicles
Deferred compensation results in current income and is
subject to an excise tax, when it is earned or becomes
vested, if the plan does not meet specific requirements
What is IRC 409A?
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Applies to employees, directors and “other
service providers”
Applies in addition to 451 constructive
receipt rules
409A contains very specific rules
governing the timing of deferrals, timing of
distributions, funding methods and various
other aspects of deferred compensation
How does the IRS define deferred
compensation?
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Legally binding right to compensation received
in one taxable year, with actual or constructive
receipt of income in another
Legally binding right does not exist if Company
has discretion to reduce compensation after
services are performed
Legally binding right does exist if:
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Discretion is available only on a condition
Lacks substantive significance
What plans are subject to 409A?
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Definition is very broad and includes:
Elective deferred compensation
 Non-elective arrangements (e.g. SERPs)
 457 (f) arrangements
 Certain types of severance
 Certain plans outside the United States
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What plans are subject to 409A?
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Example:
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Consultant prepares PowerPoint presentation for
annual bonus
Performance period for annual bonus is the
calendar year
Compensation Committee “approves” plan design
Bonus plan document is drafted but is not formally
adopted
No payment date is specified for the bonus
Payment is made six months after the end of the
calendar year
Key issue: “Legally binding right”
What are the exceptions to 409A?
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Customary payroll timing
Short term deferrals
Certain equity compensation
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Non-discounted options
Restricted stock
Stock Appreciation Rights (SARs)
Restricted property
Arrangements between partners and
partnerships
Separation pay arrangements
Agenda
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Introductions
General Scope of IRC 409A
409A Compliance and Equity
Compensation
Valuation Methodology
Frequently Asked 409A Questions
Audience Questions
What are the penalties for noncompliance?
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If there is a violation, affected service providers owe:
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Current tax on deferrals for current year and all prior years (to
the extent not subject to a substantial risk of forfeiture)
Interest at underpayment rate + 1% from original deferral date
Additional tax of 20% of the taxable compensation
If plan is not drafted correctly, all plan participants could
be “affected” and all post-2004 deferrals taxable
Date to amend plans for 409A compliance will likely be
extended beyond 12/31/06
Timing of service recipient’s deduction not affected
Few employers providing tax gross-up payments
How does 409A affect Stock Options
and SARs?
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Non-discounted options not subject to Section
409A
Similar treatment now extended to all SARs
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private and public companies
cash and stock settled arrangements
Exercise price may not be less than the “value”
of the “service recipient stock” on the “grant
date”
Tax on vesting for discounted stock options &
SARS
Concepts apply to LLCs and partnerships
What is the Grant Date?
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Grant date critical for measuring compliance
Terms of the grant must be “irrevocably established”
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What about letter agreements to new hires?
Compare to FASB Position under FAS 123(R)
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Board approval date is the grant date if:
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employee cannot negotiate key terms and conditions between the
approval date and notification date and
terms are communicated within a “reasonably short period of time”
after the approval date
Need for internal controls on granting practices
What is the Grant Date?
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A “modification” triggers the grant of a new stock right
Does a new stock right comply with 409A on re-grant?
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Option repricings
Exception for M&A option exchanges
An extension or renewal is treated as an additional
deferral feature from grant date, so 409A applies
Limited exception under proposed regulations allows for
extended post-termination exercise period until
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end of calendar year or, if later
two and one-half months
What is Service Recipient Stock?
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Only “service recipient stock” qualifies for exception
Covered entities:
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50% or more subsidiaries
20% or more joint ventures with legitimate business criteria
Covers publicly traded stock or, if none, the most
valuable form of common stock in the aggregate
Issues under the proposed regulations:
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preferred stock ineligible
multiple classes of common stock
non-publicly traded subsidiaries
What is the Value for a Private
Company?
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Value determined "by the reasonable application of a
reasonable valuation method" – what does that mean?
Unreasonable to use
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a previously calculated value that fails to reflect all material
information, or
a calculation that is more than 12 months old
Two primary safe harbors
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Written valuation report for illiquid stock by person with
significant knowledge and experience - unavailable if:
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company more than 10 years old
liquidity event is within 12 months after the option grant or
put/call rights on stock
Independent Appraisal
Agenda
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Introductions
General Scope of IRC 409A
409A Compliance and Equity
Compensation
Valuation Methodology
Frequently Asked 409A Questions
Audience Questions
What guidelines has the IRS given
for 409A valuations?
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“Reasonable method, reasonably and
consistently applied”
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the value of tangible and intangible assets of the
corporation;
the present value of future cash-flows of the
corporation;
the market value of stock or equity interests in similar
corporations and other entities engaged in
businesses substantially similar to those engaged by
the corporation; and
other relevant factors, such as control premiums or
lack of marketability
How is a typical enterprise valuation
different from a 409A valuation?
Determine Total
Enterprise
Values (TEV)
using various
methods
Model capital
structure
(liquidation
preferences,
conversions,
options, etc).
Determine
common stock
valuation using
allocation
method
Specific to 409A (and other
option plan related valuations)
What does a full valuation entail?
Approach
Method
Market Approach
Public markets
M&A transactions
Private placements
Asset Approach
Liquidation value
Replacement cost
Income Approach
Discounted cash flows
Scenario analysis
(Embedded) options
Company Specific
Prior equity events
Other relevant factors
What complexities arise due to the
capital structure?
Options
Exercised
Series B
Liq. Pref.
Series A
Liq. Pref.
Series B
Caps
Series A
Caps
Series B
Converts
Series A
Converts
Proceeds
($ MM)
40
35
30
Common
25
Options
20
Series A
15
Series B
10
5
-
10
20
30
40
50
60
70
Equity value ($ MM)
80
90
100
What are the different value
allocation methods?
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Current Method
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Option Method
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Value common as if a liquidity event occurs today
Apparently widely used, but only appropriate in limited
circumstances
Either Black & Scholes or binomial trees
Depends on some critical inputs such as volatility and
exit horizon
Probability Weighted Expected Return
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Valuation analysis based on various exit scenarios
(IPO, trade sale, liquidation)
Highly dependent on a handful of assumptions
How can you account for the
evolution of value?
Scenario 1
$ 150 MM
30%
Year 2
$ 75 MM
10%
Year 1
$ 40 MM
50%
60%
10%
Scenario 2
$ 50 MM
40%
Scenario 3
$ 0 MM
Agenda
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Introductions
General Scope of IRC 409A
409A Compliance and Equity
Compensation
Valuation Methodology
Frequently Asked 409A Questions
Audience Questions
Frequently Asked Questions
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What 409A issues arise in M&A
transactions?
Frequently Asked Questions
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How can IRC 409A impact my ability
to go public?
Frequently Asked Questions
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Can I do the section 409A valuation
myself?
Frequently Asked Questions
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How does IRC 409A relate to
FAS123R?
Agenda
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Introductions
General Scope of IRC 409A
Compliance with 409A
Valuation Methodology
Frequently Asked 409A Questions
Audience Questions
Audience Questions
Thank you
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This presentation can be downloaded at
http://www.merger.com/409awebinar
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Presenter contact information:
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Elliot Williams, Mirus Capital Advisors
 williams@merger.com; 781-418-5932
Bas van der Brugge, Mirus Capital Advisors
 brugge@merger.com; 781-418-5941
Alexander G. Lifson, Deloitte
 alifson@deloitte.com; 617-437-2546
Andrew C. Liazos, McDermott Will & Emery
 aliazos@mwe.com; 617-535-4038