The FASB recently ratified an EITF decision and approved issuance of an Accounting Standards Update on “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period” (their words, not mine).
What the Heck?
I was completely baffled as to when an award would have a performance condition that could be met after the end of the service period. After all, isn’t the period over which the performance goals can be met the very definition of a service period? So I spoke with Ken Stoler of PwC, who translated this into English for me.
Turns out, it’s a situation where the award is no longer subject to forfeiture due to termination of employment but is still subject to some sort of performance condition. Here are two situations where we see this occur with some regularity:
Retirement-Eligible Employees: It is not uncommon for companies to provide that, to the extent the goals are met, performance awards will be paid out to retirees at the end of the performance period. Where this is the case, a retirement-eligible employee generally doesn’t have a substantial risk of forfeiture due to termination but could still forfeit the award if the performance goals aren’t met.
IPOs: Privately held companies sometimes grant options or awards that are exercisable/pay out only in the event of an IPO or CIC. The awards are still subject to a time-based vesting schedule and, once those vesting requirements have been fulfilled, are no longer subject to forfeiture upon termination. But employees could still forfeit the grants if the company never goes public nor is acquired by a publicly held company.
The EITF’s Decision
The accounting treatment that the EITF decided on is probably what you would have guessed. You estimate the likelihood that the goal will be met and recognize expense commensurate with that estimate. For retirement-eligible employees, the expense is based on the total award (whereas, for other employees, the expense is also commensurate with the portion of the service period that has elapsed and is haircut by the company’s estimate of forfeitures due to termination of employment).
For example, say that a company has issued a performance award with a grant date fair value of $10,000, three-fourths of the service period has elapsed, and the award is expected to pay out at 80% of target. In the case of a retirement-eligible employee, the total expense recognized to date should be $8,000 (80% of $10,000). In the case of an employee that isn’t yet eligible to retire, the to-date expense would be, at most, $6,000 ($80% of $10,000, then multiplied by 75% because only three-fourths of the service period has elapsed). Moreover, the expense for the non-retirement-eligible employee would be somewhat less than $6,000 because the company would further reduce it for the likelihood of forfeiture due to termination of employment.
The same concept applies in the case of the awards that are exercisable only in the event of an IPO/CIC, except that, in this situation, the IPO/CIC is considered to have a 0% chance of occurring until pretty much just before the event occurs. So the company doesn’t recognize any expense for the awards until just before the IPO/CIC and then recognizes all the expense all at once.
Doesn’t the EITF Have Anything Better to Do?
I had no idea that anyone thought any other approach was acceptable and was surprised that the EITF felt the need to address this. But Ken tells me that there were some practitioners (not PwC) suggesting that these situations could be accounted for in a manner akin to market conditions (e.g., haircut the grant date fair value for the likelihood of the performance condition being met and then no further adjustments).
I have no idea how you estimate the likelihood of an IPO/CIC occurring (it seems to me that if you could do that, you’d be getting paid big bucks by some venture capitalist rather than toiling away at stock plan accounting). And in the case of performance awards held by retirement-eligible employees, my understanding is that the reason ASC 718 differentiates between market conditions and other types of performance conditions is that it’s not really possible for today’s pricing models to assess the likelihood that targets that aren’t related to stock price will be achieved. Which I guess is why the EITF ended up where they did on the accounting treatment for these awards. You might not like the FASB/EITF but at least they are consistent.
I’m on the east coast, and we’ve had a long and brutal winter this year (at least by this California girl’s standards). So you may be able to imagine that I (along with millions of others oppressed by the frigid weather) breathed a huge sigh (not to be confused with a sigh of relief) when the famous groundhog, Punxsutawney Phil, saw his shadow on this year’s Groundhog Day (February 2nd). The folklore says that when the groundhog sees his shadow, winter will continue at least another 6 weeks – not welcome news for those of us who have been freezing for way too long.
What does Groundhog Day have to do with stock plans? What I wanted to suggest is that if there were a groundhog used to forecast stock plan activity (perhaps a cousin of the weather predicting one in Pennsylvania), I would bet that this year he’d be seeing his M&A shadow, suggesting a blockbuster year is ahead for M&A activity. The buzz is virtually everywhere from the Wall Street Journal to firms like Morgan Stanley and issuer companies themselves (to name only a few – there are many others) predicting a very robust M&A market this year.
Why We Care About M&A
Stock plan professionals know that a merger or acquisition often involves stock plans. Grants from an acquired company may be assumed or cancelled. New grants may be issued to incoming or existing employees as a result of the transaction. Not only is there likely to be stock plan activity, but it is possible we could be seeing record volumes and values of grants. Last week’s acquisition of WhatsApp by Facebook included $3 billion in restricted stock unit shares alone.
Why You Should Care About M&A
It’s important that stock plan administrators get a seat at the table in M&A task force meetings or discussions. Historically, it was not uncommon for the stock plan group to be among the last to know about the latest M&A activity, sometimes after the terms of the deal had been finalized. If stock plan shares are going to be a component of the transaction in any form, the stock plan group needs to be involved.The last thing you want is to find out that a deal is done, and the terms are just too challenging to administer. Or, they can be handled, but only with great effort and time consuming labor involved.
Brush Up On Your M&A Needs and Wants
Here are a few suggestions to get your brain working on the M&A front:
Put your feelers out. M&A may or may not be a present internal topic of discussion, but you can start the discussion. Let key decision makers know that you want to be involved from the get-go should the M&A bug take hold in your company. It’s not too soon to have a conversation – even if you’re not aware of any imminent activity.
Brush up on what you’d actually need if an M&A transaction landed on your doorstep. Sure, you may not be able to predict everything you’d need right now, but you can remind yourself of the key things that you’d likely want to know if someone was standing at your door informing you that your company just acquired that XYZ company down the block. It’s not uncommon for there to be little or no advance warning for a merger or acquisition. In thinking through the types of things you’d need to know, you’ll be much better prepared if and when that day comes.
With the most promising M&A season in years upon us, now is a great time to revisit the NASPP’s M&A portal. There are articles to remind you of what you need to know if you find yourself handling M&A activity. There is also a sample M&A Conversion Checklist and other tools to ease you through the process.
Only time will tell if our fictional stock plan groundhog would have been right. Given the accuracy of the groundhogs so far this year, perhaps it’s time to get ahead of the game on this one.
These were the words uttered recently by a stock plan manager in reference to managing a “small and simple” merger project internally with no additional resources.
Relatively few stock plan managers found themselves in this situation last year. We saw a dramatic decrease in M&A activity in 2009, which is no surprise given the condition of our economy. However, the second half of the year did bring with it increased M&A activity, and news sources are all abuzz with anticipation for 2010.
Even though a merger or acquisition may be exciting for shareholders and a great way for a company to grow, it can be a serious undertaking for a stock plan manager. If an acquisition or merger is potentially in your future, start brainstorming now on what that project management will look like for you and your team.
The Left Hook
What’s the big deal, you ask? Just give me the employee and grant data along with the terms of the transaction, and I’ll throw it in Excel, work my magic and have the imports ready to process. (I mean, you should see how smooth my annual grant procedures are!) Well, if there’s one thing you can guarantee about a merger or acquisition, it’s that some part of the process of gathering and crunching your data will not go as planned. It could be something as clear cut as a spreadsheet with mismatched data (say names matched with the wrong SSNs) sent to you by the other company or a real doozy like finding out that the grants in an international location were actually all out of compliance with regulations in that country.
So, expect the unexpected when projecting the amount of time you’ll need to process the transaction and leverage your friends and peers who’ve gone through a merger or acquisition themselves. In fact, ask around at the next NASPP chapter meeting you attend and find out who’s had experience with M&A (even if you’ve done a few yourself) and ask them for just one issue they encountered in their transaction that they weren’t expecting. You can tuck those thoughts away in your “just in case” file and pull them out if your company brings you a merger or acquisition this year. If you’re looking for a more comprehensive approach to being prepared, enroll in our online education program, “Tackling Equity Compensation Issues Related to Mergers and Acquisitions,” and get a heavy dose of the due diligence considerations that you’ll want to know to put together a smooth transaction.
The Decision Dilemma
If you will be assuming any portion of the outstanding stock grants, then there are a lot of issues to consider. Converting grant data means really identifying the administrative, tax, and financial accounting consequences your decisions and finding the best balance for your company. For example, will you be converting just shares outstanding or including historical data as well? It may make sense to convert both outstanding and historical grant data because you will be acquiring ISO grants and dealing with shares purchased from an ESPP. Having the historical data makes tracking disqualifying dispositions easier. However, the “new” historical data will impact reports you run for periods prior to the transaction and you will need to accommodate the additional shares that will appear to be granted from your plan. For many issues, you will find that there all your choices have a downside. Decide what works best for your company by bringing other departments (like payroll and finance) in on the conversation and testing your strategies out in a mirror database before going live.
Think Outside the Box
So, that brings me back to the idea of how to manage your resources on a merger or acquisition. If you have a large stock plan management team and are dealing with a relatively small acquisition, you might be able to allocate enough resources to complete the transaction internally. However, if you are a one-person team or one that is already pushing the envelope on time commitment, you should give outsourcing a serious look.
Of course, you want to make the most of your consulting dollar! That means getting multiple quotes and asking the right questions. Ideally, if you’re getting help on your merger or acquisition, the individual or firm you bring in on the project will have experience with a similar transaction. However, no two transactions are the same. You know your company’s history, administrative priorities, and database best. It’s possible that you are the best person for the job or that your company is just not comfortable with handing over any part of the transaction to an outside resource. If that’s the case, you can still get help for your project. Think outside the box and bring someone in to help with your standard administrative responsibilities and free yourself up to focus on the merger or acquisition.