Three Keys to a Good Equity Compensation Plan

Having worked with a number of companies and equity compensation plans over the decades, I paused the other day to reflect on what makes for a “good” plan in my experience. In thinking this through I think there are three keys which help make an equity plan “good”:

  • Compliance
  • Best Practices
  • Flexibility

Compliance

Seems simple, but a good equity plan ensures that it complies with all the applicable rules. These rules include the Securities and Exchange Commission rules, the listing exchange (NYSE/NASDAQ) rules, the tax rules, and accounting rules.

Best Practices

A good plan reflects the current thinking of what constitutes “best practice” with respect to an equity plan. For example, today’s good plans typically have a minimum vesting period for awards, have some form of double-trigger protection for change-in-control, and are likely to place a limit on the number of shares that can be granted as full value awards (stock-settled awards other than stock options or stock appreciation rights).

Flexibility

Good equity plans also manage to balance compliance and best practices with flexibility, so that the plan itself does not unintentionally box the company into a particular action but instead enables the company to determine what is to occur, i.e., maintaining the most flexibility while still being in compliance with applicable rules and following best practices. Flexibility itself often is not fully understood until an unforeseen event occurs and the equity plan is put to the test.

Conclusion

I listed the keys for a good plan in order of their applicability. In order to have a viable equity plan, it has to comply with the applicable rules, i.e., compliance. To have a better equity plan, it should reflect current best practices in its provisions (vesting, CIC, award limits, share limits, etc.). Finally, to be a good plan, an equity plan needs to have sufficient flexibility to allow the company to address issues that arise, even if not expected.

In my experience, the hardest thing for an equity plan to do is to incorporate adequate flexibility and reflect current best practices. Sometimes, compliance can be a stretch, but that is a baseline which needs to be met and most plans do an adequate job of following the applicable rules. Many plans also do a relatively good job of incorporating best practices at the time they are adopted. The toughest thing is drafting an equity plan to ensure there will be sufficient flexibility.

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