With Australian M&A activity at a record pace in the first half of calendar 2021, and with no sign of slowing down, boards in ASX-listed companies may need to prepare for potential takeover offers from both financial sponsors and strategic buyers in the near future.
Remuneration committees will also have to consider how to treat unvested equity incentives on foot in the event of a takeover. The treatment should be fair to employees while allowing the board to maximise value for securityholders.
In deciding how to treat unvested equity on change of control, aspects to consider include:
- The proportion of the vesting period that has elapsed
- The performance to that date
- Whether it is likely the executive will remain in employment after the change in control
- The length of service of the executive
- Market practice
- Possible bidder conditions
Most modern plan rules give the board high degree of flexibility to consider all relevant circumstances for vesting of equity on foot in the event of a change of control.
Some plan rules are configured to have a default treatment of the most recent equity grant that is different than for other grants on foot. For example, in the event of a change of control, unvested equity in the first year of the LTI vesting period (i.e., the most recent LTI grant typically) may be allowed to vest in proportion to the time from grant to the first anniversary from the grant date. That is, if a change of control occurs six months into the vesting period, half of the equity granted for that LTI will be allowed to vest regardless of performance. For other unvested equity grants on foot the board will have regard for the portion of the total vesting period served and the progress towards performance conditions.
In general, Australian market practice suggests either full vesting or pro-rated vesting based on service and performance. However, the board should consider all relevant circumstances when deciding how to treat unvested equity. The nature of the buyer and the plans for the company post-transaction may be additional factors to consider in arriving at a vesting outcome that is fair to both employees and shareholders in the listed company.
Consider the example where a financial sponsor is successful in a buy-out of a listed company. Executives in the target company may pocket multiples of base salary in the form of accelerated equity that vested with the change of control. If key executives are retained by the buyer, they will typically show up the next day on a new package including participation in a management equity plan that can be even more lucrative than the incentives they were offered in the listed environment. Should the board consider the windfall and participation in new equity plans for retained executives when deciding whether to accelerate LTI grants on foot? In the US the practice has been for a percentage of unvested performance equity (e.g. 50%) to be rolled over as a buy-in to management equity in the new company, with the other 50% cashed out on the change of control.
When considering all relevant circumstances, the board may want to consider two additional factors in treatment of unvested equity: the nature of the buyer and what executives may be offered post-transaction by the new owners.© Guerdon Associates 2021 Back to all articles