We have referenced Code Section 280G and the golden parachute rules recently on this blog, and we have also discussed LLC equity incentives.  It can be fun to see how these concepts play out in a practical way in executive agreements based on some recent experiences in negotiating terms for executives in connection with private equity acquisitions.

For Code Section 280G, there are basically 3 ways that Section 280G golden parachute terms appear in employment agreements:

1. “Gross-ups” for 280G taxes (where the company makes the executive whole for any Code Section 280G taxes imposed),
2. “Best-of” provisions (where the executive receives either the total amount of payments and pays the taxes or reduces payments to a level below the threshold where Code Section 280G taxes apply, whichever results in the greatest amount of benefits being paid to the executive), and
3. “Haircuts” (where the total amount of Code Section 280G benefits are mandatorily reduced to a level below the threshold where Code Section 280G applies).

In general, gross-ups and haircuts are rare, and most agreements contain a best of provision.  So when you find the haircut terms buried in the tax boilerplate of an executive agreement where the executive is receiving profits interests that vest according to exit event performance metrics (making them certainly contingent for Code Section 280G), you will want to ensure that the executive is willing to accept giving up equity value in outcomes where the investors realize significant value.  This seems contrary to the point of equity incentives.

For LLC incentives, we are seeing that there are very material terms to be found in the operating agreements that apply to the service providers’ equity.  Specifically, we have seen some equity forfeiture provisions based on violation of any agreement between the service provider and the company without any of the qualifiers that would apply to a cause definition: willful, material, repeated, etc.  So in these cases, the executive would be subject to punitive repurchase terms on a hair trigger – arguably any minor or unknowing violation of company policy.  While this is potentially a business term that private equity firms can argue creates incentives for careful and appropriate conduct, we have seen it break a deal recently where the buyer insisted on applying it to rollover equity.

Remember to read the tax boilerplate and check the service provider terms in the operating agreements in these situations, you might be surprised what you find.