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Management Compensation in M&A - An Incentive to Plan Ahead

With unprecedented levels of cash available for investment, sellers are able to attract higher prices which come however with conditions for the legacy management team and particularly if a Private Equity (PE) buyer is on the other side of the table.

Any buyer will want to ensure that transitioning management is incentivized to do the deal but motivated to stay after the transaction and continue to enhance enterprise value (up to at least when the PE buyer intends to exit).

Diligence the heck out of existing arrangements!

The sheer volume of work associated with a deal sometimes means that for a buyer understanding management’s incentives mistakenly doesn’t become a priority. Unlike a PE investor and here’s what they will want to know:

·        What do current equity incentive awards look like? Will they vest contractually on closing or is the acceleration of vesting discretionary?

·        What is the level of payout? If amounts are large management may be less motivated to stay.

·        If the company is in the US will these payments attract excise tax?

·        Does management hold any equity outside of incentive awards?

These are important questions that the due diligence process should address.

Create an understanding with management ahead of Closing

Ongoing (post closing) management incentives should be agreed with key executives prior to closing providing comfort to the buyer that executives are on board.

Terms may be set out in a term sheet, executed simultaneously with the purchase agreement. Management may be willing to roll over equity or invest alongside the buyer and the terms for this can be included. Base salary and annual incentive are likely to remain unchanged but the transitioning management team will often receive from a PE buyer a one-time time or performance restricted award requiring them to remain until the buyer exits.

Full value stock or stock unit awards are less commonly used for this purpose because they realize a partial value even when equity reduces in value. PE buyer’s primary goal is to increase value after close.

A PE sponsor will work with the seller on the equity pool, distribution scenarios, individual allocations,and reserves for future hires and promotions and exit strategies e.g.an IPO. Upon a later sale, all unvested equity typically accelerates but in an IPO it may not.

If executives leave with awards remaining exercisable or owning equity, then a repurchase plan might be necessary.

Management terms are usually firmed up prior to purchase but plans, shareholders’agreement,and employment contracts finalized between signing and closing. Buyers want management to be energized and focused on the transaction, not spending time worrying about their livelihoods. Such terms will provide management with“skin in the game” and place pay at risk subject to performance on a long-term basis.

Management should participate in the up as well as downside and with a PE buyer incentivized to help the company grow and preserve their investment.

Don HiltonNovember 15, 2018Compensation, Mergers & Acquisitions