Chapter 45280G Analysis
One of the less glamorous, yet crucial aspects of selling your startup is navigating the complexities of a 280G analysis. Section 280G of the IRS tax code addresses payments made to executives (including founders) in connection with a change of control, such as an acquisition. These payments—often including severance packages, retention bonuses, or accelerated vesting of equity—are scrutinized to ensure they are not considered excessive, also known as "golden parachutes". This process should commence as soon as the compensation packages are agreed upon.
1. Why Does 280G Matter?
From your perspective as a founder, understanding the implications of 280G is essential because failing to properly address it can lead to significant tax consequences, including a punitive 20% excise tax imposed on the recipients and loss of tax deductions for the acquiring company. This creates a strong incentive for both parties to ensure compliance.
2. Key Components of 280G Analysis
1. Calculating the Threshold: The threshold for determining excessive payments is three times the individual's average annual compensation over the past five years. Any payments exceeding this amount are at risk of triggering the excise tax.
2. Considerations and Retentions: The specific terms and components of the compensation packages negotiated during the deal—including retention bonuses, severance payments, and equity acceleration—are critical. Every detail matters, as minor adjustments can significantly impact the outcome of the 280G analysis.
3. Shareholder Vote Requirement: Payments determined to exceed the threshold can avoid the harsh penalties if approved by shareholders. However, there's a catch: only shareholders who are not recipients of the compensation being voted on can participate in the vote. This means that founders and other key executives typically cannot vote to approve their own compensation packages.
3. Ensuring a Smooth Approval Process
Because the approval requires an affirmative vote from at least 75% of disinterested shareholders, it is crucial to maintain open, transparent relationships with your key stakeholders—particularly your lead investors. The good news is that votes typically align with the recommendations of the lead investors. Historically, rejections of these compensation packages are rare, provided relationships with stakeholders are strong and communication is clear.
Nonetheless, delays in this approval process can significantly hold up the deal's closing timeline. To avoid this, initiate the 280G analysis and shareholder approval process as soon as the terms of the compensation packages are finalized. Proactivity in this stage demonstrates diligence to both investors and acquirers, reassuring them that you're well-prepared and organized.
4. Main Takeaways for Founders
1. Understand Early: Familiarize yourself early with what triggers 280G issues.
2. Communicate Clearly: Be transparent with your investors about why certain compensation elements are necessary for the business continuity post-acquisition.
3. Be Proactive: Initiate the shareholder approval process promptly after finalizing compensation details to avoid delays.
4. Maintain Relationships: Cultivate trust with key stakeholders and lead investors to ensure smooth passage of necessary approvals.
While a 280G analysis might initially seem daunting, careful planning, clear communication, and proactive management can make this a straightforward process. Approached thoughtfully, navigating 280G becomes merely another checklist item on your path to a successful acquisition.