Commentary: Executive compensation and M&A: How not to get burned in a fire sale

Rising costs, lower prices and market skepticism led to a decrease in mergers and acquisition (M&A) activity throughout the mining sector. However, as I pointed out in my previous article, “Executive compensation and M&A: Preparing for sell-offs” (T.N.M., Aug. 19–25/13), many companies may be forced to sell off themselves or their assets soon.

For various reasons you may find that selling your company may be your best option. If so, your primary focus will be on maximizing your sale value and avoiding pitfalls that could lead to depreciated valuations, or lower interest in the purchase of your company.

Executive compensation is often identified as a positive motivator in maximizing corporate value. In our experience executive compensation packages and payouts are rarely deal-breakers, but can be powerful tools for improving the negotiation process and selling price. Foresight and diligence are required, but if done correctly, your company can avoid unfortunate executive commitment, contract and resourcing issues that may hinder the completion of a sale.

When things are not going well, the reality is that executives get nervous and update their resumés, and an uncommitted executive team can diminish your company’s selling price. One way to avoid this pitfall is to make sure that incentives are in place that motivate executives to attain the highest value for your company, retain corporate expertise (i.e., key people) and help facilitate a problem-free sale.

A sales-maximization plan can establish a special incentive for executives to strive for the highest price. With such a plan, companies establish sale-performance tiers that correlate defined bonus payments with higher sale values for stakeholders. Similar plans can be established for board members who are strongly involved in the sale.

The basic objective of sales maximization plans is to help keep executives and board members focused. Such plans establish a specific bonus opportunity that incents key individuals to obtain the highest possible selling price. Overall, individuals receive a competitive percentage of whatever premium is generated over and above a predetermined fair market value. If anyone leaves before the sale is complete, they forfeit any and all bonus they were previously entitled to. In the end, such plans enable shareholders to receive a majority of the increased proceeds of the sale and key individuals get a meaningful lump-sum payment that is solely contingent on their ability to maximize the transaction value.

If a sale maximization plan is not plausible but your company is still concerned about key executive departures early in the sales process, there is another option. A simple retention incentive plan is a positive solution that sets guaranteed incentive amounts for executives who remain in their role until the sale is finalized. Again, plan participants will forfeit any bonus they were entitled to if they leave before the sale is complete.

Executives should also know that they will be treated fairly throughout the sale process. If this is the case, your company should make sure that proper employment contracts are put in place prior to hanging out a “for sale” sign. Make sure these contracts are attractive to potential buyers — for instance, eliminate potential negative deterrents such as the right to participate in shareholder rights plans (i.e., poison pills).

Next, positive goodwill should be generated with your executives through the review of all executive employment contracts. If contracts are not in place, and your executives want some protection, contracts should be made with change-of-control provisions to protect them from sudden termination without cause.

Where real or phantom equity incentive plans are in place, details of the plans’ term sheets should be reviewed and if appropriate, all executives might be reminded that their unvested equity will be forfeited if they choose to leave before a sale is complete. Next, consider how the merger or acquisition activity will impact the equity stakes that your executive and directors currently hold. Make sure you seek expert advice on the tax impacts associated with the sale or exchange of the held equity, and make sure that all parties are prepared.

Finally, if the buyer wishes to retain existing executives and/or directors, it is possible to exchange existing real equity (options, warrants, shares) in the old company, on a tax-deferred basis, for the rights to receive or acquire shares of the new corporation. If this is a consideration, before the deal is complete you should finalize the details pertaining to the proper, tax-deferred exchange of equity for all retained executives and directors.

Share swaps are normally straightforward. However, options can be problematic if large portions are underwater. Canadian law recognizes that there was a time value included in the calculation of the original grant. Due to this fact, if there is no adjustment provision in the option plan: the purchasing company may not be allowed to cancel the underwater options until the expiry date is reached. Your company should seek expert tax advice in advance in order to understand all of its rights and related issues in dealing with outstanding options, and to stay on top of current tax laws.

If existing incentive plans include cash-based performance units or restricted units, your company needs to be aware that cash-based grants should be settled in cash as part of the transaction. If your intent is to complete an all-cash sale, all shares and options will also need to be settled in cash. Overall, all equity settlements should be clearly communicated throughout the negotiation to ensure that the required funds are available.

If the current market environment leads to the selling off of mining companies, M&A activity could pick up rapidly. The important thing is to be prepared to ensure that key people are protected and that your stakeholders maximize their returns on the sale.

In the next few months, if your company finds itself in a sale situation, practicing due diligence and managing executive compensation elements effectively will undoubtedly help maximize your corporate sale values and provide a smooth sale process, and help make sure that no one gets burned in the process.

As part of a three-part series, this second article touches on the sellers’ side of the equation. The third article will cover compensation issues related to the buy side.

— Bradley Kelly is a Partner at Global Governance Advisors, an independent board advisory firm with offices in Toronto, Calgary, New York and Miami. He specializes in performance goal setting and the strategic review, valuation and innovative design of executive compensation and corporate governance programs. He can be reached at (416) 707-4614, or brad.kelly@ggovernanceadvisors.com. Follow Bradley on Twitter @BradKellyGGA. For more information visit http://ggovernanceadvisors.com .