Executive Compensation & Incentives

It is a contractual right to a payment calculated by reference to the value of equity, so the recipient gets the economics of ownership without becoming an owner. It is entirely real and entirely enforceable; what it is not is stock. There is no cap table entry, no voting, no information rights, and no new shareholder to buy out later. For a business that wants to reward someone without changing who controls the company, it is frequently the right answer.

You can, and people do it in emails all the time, which is where the disputes come from. "Ten percent of the profits" raises a series of questions nobody agreed on: profits before or after what, measured how, paid when, and what happens if they leave in March. Every one of those becomes contested at exactly the moment the relationship has soured. Write it down properly the first time.

It is the federal rule governing deferred compensation, and it applies far more often than owners expect, including to arrangements nobody thought of as deferred compensation. The penalties fall on the individual receiving the money rather than the company, which makes it a particularly unpleasant thing to get wrong for someone you were trying to reward. Any plan paying value in a later year should be reviewed against it.

Whatever the documents say, which is why change-in-control terms matter so much. Badly drafted arrangements produce two bad outcomes: a payout that surprises you at closing and reduces the seller's proceeds, or terms so restrictive that a key person walks away mid-deal. Both are avoidable at the drafting stage and very hard to fix during a transaction.

Have it reviewed before the first payment falls due. Inherited plans routinely contain change-in-control triggers, accelerated vesting, and claw-back terms that the buyer did not fully price. Finding out during diligence is much better than finding out afterwards, but afterwards is still better than at the payment date.