Using Equity to Conserve Cash: Tips for Doing So Safely
With volatile economic conditions, some companies have been looking for ways to conserve cash, and some have considered worker pay cuts and layoffs. As an alternative, a recent White & Case memo says one strategy some of these companies are considering is replacing a portion of worker pay with equity compensation. Although replacing pay with equity can help save cash and fill a gap created by pay cuts, the memo serves as a reminder of potential issues that can arise, including those relating to employee consent, exempt employment status and tax traps. Here’s an excerpt about potential 409A issues:
While a reduction in salary alone should not trigger 409A concerns, employers should be aware that any commitment to repay the amount of reduced compensation at a later date, in the form of delayed salary payments or salary payments replaced with other consideration such as equity awards, may be a deferred compensation arrangement under Section 409A.
Under 409A, deferred compensation arrangements must comply with specific timing and other rules governing when and how deferral elections can be made. Failure to comply with the Section 409A deferred compensation requirements could exact harsh penalties on affected employees, including accelerated income taxation and a 20 percent penalty tax.
Strategies for avoiding 409A penalties include paying the deferred amount no later than the end of the short-term deferral period (for calendar year 2020 compensation, by March 15, 2021), or structuring the program without an explicit commitment to repay lost wages. In this instance, the employer could unilaterally choose to repay the forgone salary amounts at any time, even beyond March 15.
The latter strategy is risky, requiring great care in both the structure of the program and all related communications with employees. These should be crafted to avoid statements that could create an expectation of deferred payment that might rise to the level of a “reliance” claim resulting in a “legal obligation” of payment which would implicate the deferred compensation rules of Section 409A.
Even with the risks, the memo notes that for companies experiencing dips in their share price but that expect growth to return in the future, offering equity awards can be an efficient and cost-effective way of delivering a meaningful share in this growth to their employees in the long term. The memo provides suggestions for companies that want to pursue such a strategy that can help get them started on the right foot, here are a few:
Transparency is key. A strong, open dialog must evolve among management, workers and unions. Communications must clearly explain to whom the plan applies, how long it will last, why any alternative approaches were rejected, what the benefits are to employees, and most importantly why management believes the plan is essential to the company’s success and the workers’ continued employment.
Communicate how the plan affects other employee programs (if at all), such as 401(k) plans, pensions, healthcare benefits and so on. Engage human resources at every stage of the plan to evaluate the HR effects of the plan and to help with communications.
Be mindful of time limits. In many jurisdictions, there are specific regulations related to how quickly a pay modification can begin after its announcement.
As an alternative, some companies may also want to consider using equity awards not to replace pay, but to make up for benefits reductions or to replace back pay already lost during furloughs.
-Lynn Jokela, CompensationStandards.com November 12, 2020
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