In both the United States and the United Kingdom, we have seen a growing number of take privates in recent years by private equity firms. Some of these are companies that went public in recent years, especially in the US using the SPAC vehicle, and can’t maintain their long-term growth. Others are long time public companies that have stagnated and are easier to “fix”, without the pressures and visibility of the public market.

Equity incentive plans are very different in the public and private markets. In the public market annual grants are generally given. They are usually a combination of performance vesting RSUs, time vesting RSUs and stock options. They usually vest over 3 to 4 years and, once vested, have liquidity in the public market. Private equity arrangements are different. They involve one-time grants upon acquisition (or later joining of a company) and no liquidation until the company is sold.

For executives who have spent their careers in public companies, one of the big issues in private equity is the lack of liquidity. Executives are used to having stock vest, paying the withholding and then having tradeable shares of stock in the brokerage account or cash in the bank. In addition, they receive the benefits of a new grant each year.

Conversely in private equity, there is one grant made upfront and, generally, no liquidity on that grant until the entity is sold. This is often a surprise for executives, and a lot of education is needed to prepare them for the change. Indeed, many executives do not appreciate the advantages of an upfront grant at the acquisition price as opposed to annual grants at, hopefully, rising prices. What, however, is hardest for them to adjust to is the lack of liquidity. These differences require a great deal of education for the management teams so that they understand the private equity thesis and approach and that the final result can be substantially higher for them. This is particularly the case for the most senior executives since their new incentive generally is based on share of value creation, rather than reference to multiples of salary or assessment relative to their public company peer equity grant levels. Further, if designed based on public company peer comparisons, there is usually a premium for illiquidity and risk.

A more difficult issue is the depth of the public grants within the company versus the generally more limited depth of grants in the private equity owned company. In most public companies, annual equity grants go quite deep into the salaried management work force. In private equity owned companies the number of people in the management equity incentive plan is substantially lower. This is for tax and securities law reasons, as well as the conceptual difference in trying to give equity only to those executives who have significant impact on the growth of the investment with less concern for those at lower levels. The depth of participation in private equity MIPs varies greatly; from the most common participation of 20-40 executives to 100-200. While on occasion grants go deeper, those grants are usually in the form of phantom cash bonus plans that only pay out on sale of the company if the recipient is still there. While these gain appreciation at exit for those still there, they generally are not heavily valued by employees for retentive purposes.

This presents a difficulty in how to address the lack of equity grants going forward for the lower-level executives. Most would believe that the lack of continuing grants is a decrease in their compensation and would not be pleased about it. Whether this would be enough to have them seeking another job would depend on a lot of other factors, including the job market and level of their other compensation. It would, however, leave them displeased. Lack of participation in the new management equity incentive plan is often a bigger issue in the United States than in Europe because of the difference in the form of private equity awards. In the United States, awards, whether profits interests, options or some other vehicle, are granted without any cost to the executive. In Europe, sweet equity is generally used and there is a cost to the executive to acquire the interest; often this can be nominal but in certain jurisdictions this can be a meaningful amount. Hence, there is somewhat less resentment to not having the right to spend money as opposed to getting something for free. However, in both US and Europe, lower-level executives can be worse off than when the company was public and are likely to be unhappy about that.

There is often a need to address this real or perceived reduction in compensation beyond use of a phantom cash bonus plan requiring employment at exit. In doing this, generally either additional equity would need to be utilized or there would be a cash cost and likely an undesirable accounting charge. Among the options are:

• increase base salary in the value of the lost annual grant is generally not desirable because it locks in use of cash, has a cost even if the company does not grow and may make targeting base salary at market levels more difficult and inconsistent (in addition to the impact on EBITDA).
• increase annual target bonus percentages—this is more attractive since it can be structured to award growth in the company because of achievement of specific goals. However, it still potentially utilizes cash on an ongoing basis, has EBITDA impact and may lead to oversetting target bonuses above market. Of course, targets are just that and they can be geared to be stretch, which will save cash but will have issues of employee morale.
• create 3-year LTIP bonus plan based on achievement of EBITDA, revenues, free cash flow or other business factors. The issues are similar to the annual bonus increase but have a retention factor to the grant.
• do a restricted stock grant with vesting after 3 years and payment of enough cash to cover tax This gives line of sight to a payout, which is good for retention, but utilizes cash and will create some equity dilution.
• utilize the above-mentioned exit phantom cash bonus plan if the executive is employed at exit. We often see cash bonus plans utilized based on a multiple of salary which increases depending on the investor return multiple. This has the advantage that it is very simple to communicate and as a cash plan enables a large degree of flexibility on terms. However, as noted above, it can have limited current retention value because of the long line of sight unless the quantum and terms are attractive.
• do nothing special for these employees. There will be some griping but if base salary and bonus is market competitive it is unlikely to cause the loss of a significant number of employees.
• extend the depth of the MIP to cover more employees. It is likely to make employees happier, although many of them will not understand what they are receiving. To be effective as a benefit, good ongoing communications showing value will be needed. This will dilute equity, and it needs to be decided whether this will come out of the otherwise contemplated management pool or be an additional availability. Going to this depth of participation is likely to also raise securities law issues that would need to be complied with.

These issues need to be addressed on any go private, and the answers will vary company by company and deal structure by deal structure. It is beneficial to undertake detailed planning to assess proposed returns following the go private relative to the compensation and LTIP in the pre-deal public company structure, and map out how the different structures of incentive could work best for the company and different tiers of managers.

It is important that these issues are not ignored since it could lead to loss of employees, loss of morale among remaining employees, tension between the ‘haves’ and the ‘have nots’ and, in the end, incur additional cost in the guise of replacing employees or the cost of depressed performance.

Jamieson continues to be the market leader in supporting management teams going through take-privates and in the last 18 months has supported teams on take- privates with an aggregate market cap in excess of $50bn.