Level 1 Equity Plan Design, Analysis and Administration Flashcards
(102 cards)
1
Q
IRC Section 423 Primarilly Deals with what kind of plan
A
ESPP- Employee Stock Purchase Program
423 rymes with ESPP
2
Q
Tax qualified plan under IRC Section 423 - Statutory requirements
A
- Only employees are eligible to participate
- Plan must be approved by shareholders within 12 months of plan adoption
- Must carry an individual purchase limit of $25,000 per calendar year based on the FMV at the time of grant
- The option price may not be less than 85% of the FMV of the stock on the date of grant or the date of exercise (whichever is lowest = Lookback provision)
Must carry equal rights and privileges and be offered equally to all employees with certain exceptions.
Not transferable so long as the employee is alive and upon the employee’s death may only be transferred to the employee’s heirs or estate
3
Q
Tax Qualified ESPP Options expire after….
A
- 5 years if the option price is based on the FMV of the stock on the date of exercise
- 27 months if the option price is based on the lookback period
4
Q
IRC Section 423 Statutory requires they must/may omit which employees from plan elegibility
A
Must omit employees that-
* would own 5% or more of the company due to the grant
* Are “highly compensated”
May omit employees that –
* Have less than 2 years tenure
* Customarily work 20 hours or less per week or less that 5 Months per year
* Foreign-based employees
5
Q
ESPP- Price Determination
A
ESPPs are unique because they can be offered at a maximum 15% discount from Fair market value and that the discount can be taken from either the grant date FMV or the exercise date FMV. Depending upon the length of the offering period and any interim purchase periods, this ability to look back to the original grant date can represent a significant discount from the exercise date FMV.
6
Q
ESPP Definition of Option
A
Refers to the right to buys stock
7
Q
ESPP Offering Period
A
The period when rights to purchase stock under ESPP are outstanding.
Begins on the Offering Date and ends on a pre-determined exercise or purchase date.
Offering period could have a single exercise date, or continue for months or years with multiple intervening exercise or purchase period
8
Q
ESPP Enrollment or Offering Date
A
first day of Offering Period
9
Q
ESPP Grant Date
A
Offering Date for tax purposes ONLY IF the plan includes a share purchase limit for individual participants.
If the maximum number of shares is not determinable (either by a formula or absolute number stated in the plan) then the grant date does not occur until the exercise date when the number of shares is known.
10
Q
ESPP - Purchase Period or Exercise Period
A
An Offering Period may have one single purchase period that is the same length as the offering period or have multiple interim purchase or exercise periods.
11
Q
ESPP • Purchase Date or Exercise Date
A
Date in which the purchase of the stock is executed. Date the administrator receives both a notice of exercise and the payment price for the option shares. The exercise cannot be executed until both are provided for.
Date could be at the end of the offering period or at the end of each interim Purchase or Exercise Period
12
Q
ESPP Enrollment Process Requirements
A
- Subscription/Enrollment agreement prior to offering date of the first offering period
- Payroll deductions (typically capped at 10-15% of participant compensation)
- Eligible Compensation
- Automatic purchase on exercise date
13
Q
ESPP Eligible Compensation
A
Generally base pay is the best practice to use for determining source of ESPP contributions. The definition of compensation cannot discriminate against certain employees. The ESPP plan document would define the definition of “Compensation”.
14
Q
ESPP - Enrollment date
A
The first day of the offering period NOT the first day the employee enrolls in the plan.
15
Q
XYZ Corporation ESPP Plan
Tax status:
A
Tax-qualified under Code Section 423.
16
Q
XYZ Corporation ESPP Plan-
* Eligible Employees:
A
Open to employees who work at least 20 hours per week and more than five months a calendar year.
17
Q
XYZ Corporation ESPP Plan
* Offering periods:
A
Sequential every six months, starting May 1 and Nov. 1.
18
Q
XYZ Corporation ESPP Plan-
* Purchase price:
A
85% of fair market value on enrollment date or exercise
date, whichever is lower.
19
Q
XYZ Corporation ESPP Plan-
Payroll deductions:
A
No more than 10% of pay
20
Q
XYZ Corporation ESPP Plan-
* Eligible Compensation:
A
ONLY Base Salary and commissions
Excludes payments for overtime, shift premium, incentive compensation, incentive payments, bonuses and other compensation.
21
Q
XYZ Corporation ESPP Plan-
* Changes during offering periods:
A
Participants can increase or decrease contributions during offering period or withdraw from offering period.
22
Q
XYZ Corporation ESPP Plan-
* Offering Period Purchase limit:
A
No more than 2,500 shares per offering period.
23
Q
XYZ Corporation ESPP Plan
Share pool:
A
200,000
If plan runs short of shares, company makes pro rata allocation of remaining shares.
24
Q
XYZ Corporation ESPP Plan
Subscription Agreement
A
- Lets participant chose percentage of payroll to deduct, up to 10% of pay.
- Participant must agree to notify the company within
30 days after selling the shares and to arrange for withholding. - Agreement to be bound by terms of the plan.
25
Stock Grant
A full value award which gives the recipient the benefit of the underlying stock value from the date of grant, plus the appreciation, if any, thereafter. A stock grant can be offered at no cost to the recipient, at a nominal cost, at a discounted cost, or at the cost of full fair market value to the recipient. The recipient is not taxed on the value of the grant until the stock vests.
26
Stock Option
The right to purchase a share of stock at a specified price. It’s classified as an appreciation award because the recipient will only receive the value between the strike price on the date of grant and the fair market value on the date of exercise - that’s the appreciation or growth in the value of the stock between grant date and exercise date.
27
Vesting
The process of earning shares of stock or the right to purchase shares of stock over the term of an instrument (e.g. restricted stock, stock option); the process by which shares first become transferable or not subject to a substantial risk of forfeiture by satisfying continuing service- or performance-based conditions
28
Exercise
Purchase of stock pursuant to an award. Exercise can occur after vesting, or before vesting (early exercise). If the award is a restricted stock grant that requires a purchase price to be paid, that is an exercise at grant. If the award is an option, the exercise will take place after the option vests. If the option is eligible for early exercise, the purchase may be made before the option vests.
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Award Term/Expiration
The time period during which an award is outstanding, after which the right granted under the award expires.
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What is needed to Calculate Vesting?
* Number of shares awarded
* Vesting schedule
* Vesting start date
* Calculation date
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Performance Awards Characteristics – Vesting
A performance award is an award structured so that it becomes exercisable or vests upon the achievement of a specified company performance goal
* Earnings-per-share
* Revenue target
* Profitability target
* Operations or departmental goals
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Performance Awards Characteristics – Exercisability
Like service-based awards
• Can vest in one lump sum after a specified performance goal has been met
• Can vest in cumulative increments as multiple performance goals are met.
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Performance Awards Characteristics – Effect on plan share reserve
These awards will provide for a target performance level and often set forth a threshold performance level below which no shares will be earned and a maximum performance level at which the maximum number of shares that may be earned is capped.
Reduce the plan pool 1:1 at the Maximum performance level
• Company must make sure to Reserve enough shares for maximum payout without going overdrawn
34
Characteristics of Phantom Stock
Is similar to an RSA but doe not grant actual shares
* Full-value award based on value of underlying stock plus appreciation over vesting period
* Usually does not require payment of exercise or purchase price at settlement
* May settle in cash or stock
* Accounting treatment is similar to SAR
* Eligible for employer tax deduction for amount of reported compensation
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Phantom Stock Deferred compensation under Section 409A
* A “short term” deferral is exempt from 409A
* must specifically NOT include terms which would allow for a payment after the 2.5 month period.
* Payout taxed as ordinary income if compliant with or exempt from Section 409A; if not, recipient pays 20% penalty plus interest
36
Restricted Stock Award (RSA) Characteristics
* An award of stock that may or may not require the recipient to pay for the shares received
* Shares are issued at grant and held in escrow until vesting requirements are met
* Unvested stock carries same voting rights and dividends as vested stock
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Restricted Stock Units (RSU) Characteristics
* An award of the right to receive the value of a share of stock
* Does not require recipient payment or exercise price
* Does not carry voting rights but may be eligible for dividend equivalents
* Settlement on vest date unless deferred
* Shares are issued upon release (usually vest)
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Dividend Equivalent Rights (DER) Characteristics
* The right for an unvested equity award to receive an amount equivalent to dividends declared on company stock
* Usually payable on full-value stock-based awards such as RSUs and phantom stock
* Payable upon declaration in cash or deferred until underlying award vests and settles, in cash or stock
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Dividend Equivalent Rights: Declaration date
The date the Board announces a that dividend will be paid, an exchange will be made, or a transaction will occur.
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Dividend Equivalent Rights: Record date
The date the company identifies eligible shares and shareholders based on company records. This date is the cutoff for who gets the benefit/right and who does not – only those the date the company identifies which shareholders will be eligible to receive the dividend or equivalent based on the company’s records. The record date is the metaphoric line in the sand, that says, shares owned on or before this date are eligible to participate in whatever action is being contemplated, like voting or receiving a dividend, and shares purchased after this date are not eligible.who are shareholders on this date qualify even though the transaction date is later.
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Dividend Equivalent Rights : Transaction date.
The date the company delivers the payment, performs the exchange, closes the transaction, etc.
42
Methods of Tax Payment for Restricted Stock Award
Section 83(b) election is filed
* Compensation income is recognized on spread between purchase price (if any) and grant date FMV
* Company has withholding obligation* at time of filing 83(b) election on compensation income element
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Methods of Tax Payment: Restricted Stock Units when a Deferral election is filed
* Employment taxes (FICA/FUTA) due at vest on amount of appreciation between grant date FMV and vest date FMV (company has withholding obligation*)
* Compensation income recognized at distribution on appreciation between grant date FMV and distribution date FMV (company has withholding obligation*); no additional FICA/FUTA is due upon distribution
* Nonemployee deferrals are taxed at distribution only (self-employment taxes and compensation income
44
Stock Appreciation Rights
- Is based on the appreciation or increase in the stock’s price between the date of the award to the date of settlement.
- Type of employee compensation linked to the company's stock price during a preset period.
- Unlike stock options, often paid in cash and do not require the employee to own any asset or contract.
- Beneficial to employers since they do not have to dilute share price by issuing additional shares.
45
Stock Appreciation Rights Payout Amount- Cash
Less favorable accounting treatment. Calculated by the difference between grant date and settlement date FMV
= Grant Date FMV - Settlement Date FMV
46
Stock Appreciation Rights Payout Amount – Stock
More favorable in account if paid out in stock. Calculated by the difference between grant date and settlement date FMV divided by settlement date FMV
= grant date FMV - Settlement Date FMV
47
Stock Options
A stock option is a contractual right to purchase shares in a corporation for a fixed price over a fixed term
48
Stock Options
Strike/Exercise Price:
Usually the fair market value of the stock on grant date.
49
Stock Options
Term of the Option:
Varies from 5 to 10 years. Most common practice
| is a ten-year term.
50
Stock Options
Vesting Schedule:
The rights to the shares are earned over the vesting schedule of the grant.
51
Stock Options
Exercise of Options:
The optionee can choose the exercise their rights to the vested shares when the shares vest. Some options provide “early exercisability which allows for the exercise of unvested shares.
52
Grant Agreement
A written or electronic document that specifies the terms and conditions of the stock option grant.
53
Grant Agreement Required Elements
```
Name of the optionee
Grant date
Type of Option (ISO or NQ)
Number of shares granted
Exercise Price
Vesting Schedule
Expiration Date
Procedures for exercising the option
Permissible forms of payment
Termination provisions
```
54
Grant Agreement Vesting Provisions
Vesting schedules define the amount of time a service provider (employee, consultant, etc.) must work for the company before earning their rights to the shares. Vesting is measured from the “Vest Commencement Date” which can also be the grant date, or some other date as defined by the company.
55
Omnibus Equity Incentive Plan
A plan that grants multiple types of awards:
* Incentive stock options & Nonstatutory stock options
* Stock appreciation rights
* Restricted stock awards & Restricted stock units
* Performance share awards & Performance share units
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# XYZ EIP:
Equity Incentive Plan Administration
Board has broad authority to administer plan or delegate administration.
57
# XYZ EIP:
Equity Incentive Plan Eligibility
* ISOs to employees only.
* All other awards can be granted to employees, directors, consultants, any anyone else that provides services tot he company.
58
# XYZ EIP:
XYZ Equity Incentive Plan Share Reserve
Share pool = 5 million shares
* Stock Awards = 1 share
* Full-Value Stock Awards = 1.5 share
* Plan states that the Plan share reserve will be adjusted if the company implements any change in the overall capitalization of the company, such as a stock split.
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# XYZ EIP:
XYZ Equity Incentive Plan-
Capitalization adjustment provision
Share pool and plan provisions eligible to be adjusted accordingly in stock split or other capitalization adjustment.
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# XYZ EIP:
XYZ Equity Incentive Plan Exercise price
no lower than grant date fair market value
61
# XYZ EIP:
XYZ Equity Incentive Plan Term
Options expire no more than 10 years after grant date (however, Notice of Stock Option Grant stipulates 7 years)
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# XYZ EIP:
XYZ Equity Incentive Plan-
Type of Stock
Designated as ISOs or NSOs at grant
63
# XYZ EIP:
XYZ Equity Incentive Plan-
Exercise price limit
100% of FMV
10% shareholders must have exercise price of at least 110% of FMV and term of no more than five years
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# XYZ EIP:
XYZ Equity Incentive Plan-
Early Exercise
is generally not permitted
65
# XYZ EIP:
XYZ Equity Incentive Plan-
ISO Limit
No more than $100,000 worth of ISOs can become exercisable in a calendar year. Any excess treated as NSOs. (Stock Option Agreement Section 2(i)(d))
66
# XYZ EIP:
XYZ Equity Incentive Plan-
Fair Market Value Definition
the closing sales price for such stock (or the closing bid, if no sales were reported), as quoted on such exchange on the day of determination or, if the stock exchange on which the Common Stock trades is not open on the day of determination, the last business day prior to the day of determination
67
# XYZ EIP:
XYZ Equity Incentive Plan
Allowable Exercise Methods
- Cash or Check
- Stock Swap
- Same Day Sale
- Net Exercise
- Promissory Note
- Other Legal Payment
- Combination
68
# XYZ EIP:
XYZ Equity Incentive Plan-
Transferability –ISOs
Not transferable during optionee’s lifetime. Can be transferred after death.
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XYZ Equity Incentive Plan-
Transferability – NSOs
Can be transferred to family members, but only if option agreement so specifies.
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# XYZ EIP:
XYZ Equity Incentive Plan-
Vesting Schedule-
Time-based: Default is equal installments over four years (in Plan and Notice of Stock Option)
* Acceleration based on performance is OK at the board’s discretion
* Board has authority to accelerate vesting upon change in control, death, disability, or termination of participant, or achievement of performance goals.
71
# XYZ EIP:
XYZ Equity Incentive Plan-
Termination of Continuous Service (PTEP)
* Terminated for cause: Options cancelled immediately.
* Disability: Options remain exercisable for 12 months if not otherwise specified in grant agreement.
* Death: Options remain exercisable for 12 months if not otherwise specified in grant agreement.
* All Others: Options remain exercisable for three months
72
# XYZ EIP:
XYZ Equity Incentive Plan-
Events that don’t count as interruptions of “Continuous Service”:
* Sick leave
* Military leave
* Board- or CEO-approved leaves of absence that don’t exceed three months unless return guaranteed by statute, contract, or company policy
* Change from employee to consultant or from consultant to employee during term of award
* Transfers between company and affiliates or successors
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# XYZ EIP:
XYZ Equity Incentive Plan
Plan Dates
Board Adoption: January 15, 2017
Shareholder Approval: May 1, 2017
Last Amended: January 15, 2022
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XYZ Equity Incentive Plan – Stock Option Agreement-
Methods of delivering exercise notice
* Written notice (Notice of Exercise) Signed or electronically acknowledged
* Delivered in person, by certified mail, or electronic transmission to equity compensation department
* Accompanied by exercise price or execution of same-day sale through company’s designated broker
* Exercise deemed to occur upon receipt of notice and
exercise price or by execution of same-day sale.
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XYZ Equity Incentive Plan – Stock Option Agreement
Payment methods
• Cash
• Check
• Broker-assisted same-day sale
• Surrender of already owned shares
• Net exercise (if procedure is in place at time of exercise)
Company has discretion to prohibit cashless exercise.
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XYZ Equity Incentive Plan
Restricted Stock Provisions
(RSA) Default Terms
• May be awarded in consideration of past service
• New employee or consultant must pay for shares
• Company retains reacquisition right during vesting period
• Shares are issued at grant, carry voting and dividend
rights
• Vesting over at least four years, but can be accelerated based on performance criteria
• Upon termination, company automatically reacquires all stock unvested as of termination date
• Transferability subject to award agreement
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XYZ Equity Incentive Plan-
Transferability Claus-
Restricted stock units (RSU) default terms
* Right to receive value of one share of company stock
* Carry dividend equivalent rights (Section 2.17)
* Election to defer receipt of value of shares can be made
* Irrevocable
* Must be filed prior to vesting date
* Upon vesting, participant credited with number of
shares equal to units
* Can pay out as shares of common stock, cash, or a combination at company discretion
* May be awarded in consideration for past services
* Vesting no more quickly than four years, but can be accelerated upon achievement of performance
conditions
* Unvested RSUs expire immediately upon termination
* Transferable only as set forth in RSU agreement
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XYZ Equity Incentive Plan-
Restricted Stock Unit Agreement
* Each unit represents right to receive one share
* “In the event of a conflict between the terms and conditions of the Plan and the terms and conditions of this Agreement, the terms and conditions of the Plan shall prevail”
* Tax payment methods allowed: cash, withholding shares issued, delivering previously owned stock (not to exceed maximum individual statutory rate in the applicable jurisdiction – NEW 2018)
* Change from employee to consultant and vice versa is not termination of service
* Unvested portion of awards expire upon termination
* RSUs settled in stock
* Fractional units paid in cash when all units have fully vested
* Nontransferable except by will or laws of descent
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XYZ Equity Incentive Plan-
Notice of RSU Grant
* Standard individual award elements
* Four-year annual vesting schedule
* Fractional units rounded to nearest whole unit
* Conflicts with RSU grant agreement, grant agreement trumps Notice so fractional units are instead paid out in cash on last vesting date
* Versions in English control if in conflict with versions translated into other languages
80
XYZ Equity Incentive Plan-
Performance share awards (PSA) Default Terms
May be awarded in consideration of past service
* New employee or consultant must pay par value
* If intended to qualify under 162(m), performance conditions must be compliant with regulations and board must certify performance before vesting occurs
* Shares are issued at grant, carry dividend rights, dividends are paid upon vesting
* Shares will be paid out as soon as possible after expiration of the performance period
* Unearned/unvested PSAs are forfeited at cancellation date.
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Fair Labor Standards Act (FLSA)
Require awards that have less than six months exercise period to be included in overtime calculations for nonexempt employees.
Exempt rights may not be exercisable for at least six months after grant:
* Section 423 ESPP with exercise period of less than six months
* Options with vesting schedules of less than six months
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A plan prospectus
A summary of the option terms, description of the options' tax consequences, and other information to help employees decide whether to exercise options or not.
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XYZ Equity Incentive Plan Change in Control (CIC) Triggers
* Any person or group is or becomes the Beneficial Owner, directly or indirectly, of more than 50% of the total voting power of the voting stock of the Company, including by way of merger, consolidation, or otherwise;
* The sale, exchange, lease or other disposition of all or substantially all of the assets of the Company to a person or group of related persons, as such terms are defined or described in Sections 3(a)(9) and 13(d)(3) of the Exchange Act;
* A merger or consolidation or similar transaction involving the Company;
* A change in the composition of the Board occurring within a two-year period, as a result of which fewer than a majority of the Directors are Incumbent Directors; or
* A dissolution or liquidation of the Company.
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Stock Purchase Transaction
The buyer purchases all outstanding shares of the seller and the seller would cease to exist. Typical with private company sales, less common for public company sellers. Employees are either integrated into the buyer or terminated.
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Merger Transaction
Acquisition subsidiary is formed by the buyer. Buyer and seller both seek approval from shareholders. If approved, the seller and the acquisition subsidiary merge. Sometimes, the buyer may also merge with the acquisition subsidiary. Employees are either integrated into the new subsidiary, or into the buyer or terminated.
86
Tender Offer Transaction
Requires buyer to appeal directly to shareholders with an offer to purchase any outstanding shares at an above-market price. If the buyer is successful, it gains controlling interest in the company via share purchases or elects new board members who will vote in favor of the buyer. The buyer may then complete the transaction like a merger transaction. The seller no longer exists as an independent entity and employees are either integrated into the buyer or terminated.
87
Asset Deal
The buyer may acquire some portion of the seller. The seller and buyer still exists after the transaction.
Employees who are part of the purchased portion of the seller will be hired by the buyer and terminated by the seller. “Acqui-hire” is when the buyer purchases a business division with purpose of retaining all employees.
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NEFS
Non-Employee Former Spouse
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Transfers & Issuances of Options with Diviorce
* Form S-8 covers shares issued to an NEFS for awards covered by public company S-8 filing
* Company must provide NEFS with S-8 prospectus information
* Rule 701 exemption covers NEFS acquisitions as a “family member” for non-public company issuances
* Issuances to executives under ‘33 Act Section 4(a)(2) private placement exemption can also cover offerings to NEFS
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How does offering period effect dilution?
The longer the offering period, the more dilutive the plan, since employees are more likely to purchase their shares at a substantial discount
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Shares that reduce the plan reserves:
1. Option exercises
2. RSU/RSA releases
3. ESPP purchases
4. Pour over to other plans as defined by the plan provisions.
5. Fungible Shares
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Fungible Shares
Some plans define that certain equity types use a ratio other than 1:1 when issuing shares. For example some plans require that for every 1 RSU share granted, the plan will use 2 shares. Therefore, the transfer agent should be made aware that an RSU release of 100 shares will actually reduce the plan reserve by 200 shares.
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Cash/Exercise & Hold
The optionee must pay the option cost and any taxes due, out of pocket, for the shares being exercised. The shares exercised will be issued to the optionee.
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Same-Day-Sale
This is a broker assisted transaction. The broker will sell 100% of the shares being exercised. The option cost and taxes due would be paid for from the proceeds of the sale. The balance of the proceeds will be paid to the
optionee. The shares exercised will be delivered to the broker.
95
Sell-to-Cover
This is a combination of Same-day-sale and Cash. The intention is to sell only a certain amount of shares, typically enough to cover the cost of the options and any taxes due. The option cost and taxes due will be paid for by the proceeds from the shares sold. The balance of shares not sold will be held by the optionee.
96
Net Exercise
Net exercise is similar to Sell-to-cover, however instead of selling the shares to cover the costs of exercising, the company will withhold enough shares to cover the cost of the exercise. The net amount of shares exercised will be issued and delivered to the optionee. No sale occurs of the shares. Not all plans allow for this method of exercise
97
An optionee with an ISO who conducts a disqualifying disposition of stock in the XYZ EIP must
notify the company about the disposition.
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Recapitalization
Recapitalization is an internal reorganization of the capital structure of the company. Typically this involves a change to the type or number of securities outstanding and sometimes requires an amendment to the company's charter documents.
Causes Stock splits.
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dividend reinvestment plan (DRIP)
a program that allows investors to reinvest their cash dividends into additional shares or fractional shares of the underlying stock on the dividend payment date.
100
Reverse stock split
a change in the capitalization of a corporation that DECREASES the number of securities outstanding and adjusts the value of the securities UPWARD.
EX)if you own 10 shares of $10 stock, a 1 for 2 split will give you 5 shares of $20 stock. Again, you still own $100 worth of shares but now that value is represented by 5 shares instead of 10 shares.
101
Forward Stock Split
a change in the capitalization of a corporation that INCREASES the number of securities outstanding and adjusts the value of the securities DOWNWARD.
EX) if you have 10 shares of $10 stock, a 2 for 1 split will give you 20 shares of $5 stock. You still own $100 worth of shares but now that value is represented by 20 shares instead of 10 shares.
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PSA/PSU
Performance Stock Award/ Performance Stock Unit.
Acts as RSA/RSU but have Performance based vesting schedules.
