Structuring Incentive Equity in Private Equity-Backed Companies

Description

Equity-based incentives can be critical to retaining key personnel when private equity enters the picture. Investors and company management should have a mutual interest in designing equity incentives that are tied to the return on investment received by the equity investors. But the provisions can be complex and must contemplate various scenarios relating to both the employees and the company.

Typically, private equity investors will control the decisions regarding grants, repurchases, and the overall size of the incentive equity pool. Restrictive covenants can include noncompete covenants, nonsolicit agreements, confidentiality agreements, and transfer restrictions, which may extend beyond the incentive equity holder's period of employment.

The company's organizational documents may limit the timing and amounts of distributions. Typical limitations include distributions before the funding of committed capital, distributions made concerning unvested incentive equity, and tax distributions.

Vesting can be time-based, value-based (or a combination of the two), or event-driven. The parties should consider whether vesting schedules (and employee incentives to remain with the company) extend beyond a future sale. Regardless of the vesting provisions, a buyer may want management to convert a portion of the proceeds from their incentive equity to capital interest in the company to align their interests with the buyer.

Listen as our authoritative panel discusses these and other issues related to equity-based incentives in private equity-backed companies.