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E-MailAdam J. Shapiro and David E. Kahan are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell Lipton publication.
As companies seek to shore up their balance sheets, we expect to see an increase in private investments in public companies (often referred to as “PIPEs”). This post outlines key issues with respect to executive compensation arrangements that may arise in connection with PIPE transactions.
Review Applicable Change of Control Provisions. Parties to a PIPE transaction should carefully review target company compensation arrangements to determine whether the investment may constitute a change of control, and whether it can be structured in a manner that would avoid that result.
Share Acquisitions. The acquisition of a specified percentage of a company’s stock or voting power (often 20% or 30%) is a common change of control trigger in executive compensation arrangements. However, the share acquisition prong frequently excludes from the change of control definition acquisitions directly from a company. Assuming a plan includes a “direct investment” exception, a typical PIPE transaction would not constitute a change of control for purposes of the applicable arrangement. It is worth noting that the NYSE and Nasdaq generally require shareholder approval of issuances of company securities representing more than 20% of a company’s outstanding shares or voting power and that navigating these requirements may present additional complexity.
Board Changes. If a PIPE transaction involves a sufficiently large stake, the investor may negotiate company board representation in connection with the transaction. Typically, the board composition prong of a change of control definition requires a change in the majority of the board that is not approved by the incumbent directors. Because a PIPE investor’s board designees will typically be approved by the incumbent board and are not likely to represent a change in a majority of the board, a PIPE transaction is unlikely to activate the board change prong of a change of control provision.
Multiple Investors. PIPE transactions involving multiple investors present special considerations in the change of control analysis. While multiple investors may exceed the applicable change of control threshold if the investments are aggregated, change of control definitions may treat independent investments as separate such that they would not constitute a change of control so long as each individual investment is below the applicable threshold. The analysis of a multiple investor transaction often hinges on whether or not the investors would be treated as a “group” for securities laws purposes, and it may be desirable to structure the investments in a manner that demonstrates the independence of the investors.
Obtain Waivers if Necessary. In the event that a PIPE transaction would constitute a change of control under applicable compensation arrangements, a target company and/or the potential investor may want to “de-activate” the change of control provisions with respect to the particular investment. However, because change of control provisions frequently appear in bilateral agreements with employees, employee consents may be required to achieve this result. A target company that agrees to obtain change of control waivers should obtain them concurrently with the execution of the investment agreement so that individual employees do not potentially hold effective veto rights with respect to the consummation of an investment. Companies should also ensure that any such waivers do not violate Section 409A of the tax code with respect to deferred compensation arrangements.
Potential Applicability of Section 280G. Regardless of whether a PIPE transaction triggers a change of control under a company’s compensatory arrangements, it may constitute a change in ownership or effective control for purposes of Sections 280G of the tax code, the golden parachute excise tax provisions, as an acquisition of 20% of a company’s voting power results in a rebuttable presumption of a change in effective control for purposes of Section 280G. The parties to a PIPE transaction should analyze the impact of Section 280G and create the best possible record to rebut that presumption.
Impact on Equity Awards. PIPE transactions are dilutive to shareholders and to equity award holders. However, because the new shares or other securities acquired by the PIPE investor typically are issued at arms-length in a value for value transaction, an adjustment to existing equity awards generally will not be appropriate in connection with a conventional PIPE transaction.
Post-Investment Negative Covenants. PIPE investors frequently secure negative covenants requiring their consent for significant post-investment company actions. While such negative covenants do not always (and often do not) address compensation matters, they may require general ordinary course conduct of business and, in some cases, specifically require investor consent to compensatory actions or agreements, especially in the area of equity compensation. As a practical matter, a PIPE investor is likely to have significant input into material company decisions—compensation-related or otherwise—regardless of whether it holds specific contractual rights.
Shareholder Votes. A PIPE investor often will hold a significant voting bloc. This bloc can dilute to some degree the influence of larger shareholder organizations and proxy advisory firms with respect to say-on-pay and other shareholder votes, but also reinforces the importance of securing the investor’s support for company initiatives submitted for shareholder approval. A company that knows at the time of a PIPE investment that it plans to seek shareholder support for a new equity compensation plan at an upcoming shareholders’ meeting may wish to secure a binding commitment from the investor to vote in favor of the proposal.
Coordinate with Third Parties. Companies should be mindful of the need to coordinate with third parties (in addition to company management) to the extent necessary. For example, if a company determines to amend a rabbi trust arrangement to eliminate a funding event in connection with a particular PIPE transaction, the company may need to work with the trustee to secure the amendment prior to the consummation of the proposed transaction.
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With a basic understanding of the key issues that may arise in the context of a PIPE transaction, a target company and its advisors can chart the most sensible course with respect to compensation matters and minimize any unintended and potentially costly effects of a vital capital raise.
