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Article | Executive Pay Memo North America

Market trends in private equity portfolio company long-term incentives

By Scott Oberstaedt , Josephine Gartrell, J.D. and Dan Leon | August 18, 2022

We analyze long-term incentive plans in recent private-equity-backed IPOs and portfolio companies. 
Executive Compensation|Mergers and Acquisitions

With over $1 trillion in funds waiting to be invested, private equity (PE) firms are always searching for companies to take over. For companies that are negotiating with PE about a takeover, the size and form of any long-term incentive plan (LTIP) offered by new PE owners is a major part of the process.

An equity-based LTIP can serve as a critical retention, attraction and motivation tool for executives and key employees under new ownership.

The LTIP plans put in place by PE owners tend to be higher risk and provide a higher potential reward than public company LTIPs. PE portfolio companies are often highly leveraged, which reduces the equity value of the company upon investment and subsequently increases the upside potential on any equity compensation. However, there is also a higher probability of bankruptcy, which could make the equity awards worthless. In addition, performance conditions are often attached to the LTIP grants, which may not be achieved, thus resulting in forfeiture of the awards.

There are five main LTIP design elements that any PE-owned portfolio company should consider before adopting such a plan: the size of the equity pool, the equity vehicles used, participation rates, vesting requirements, and liquidity opportunities.

Size of the equity pool. WTW research into 27 PE-owned portfolio companies that recently conducted an initial public offering (IPO) showed that, by the time of the IPO, the median company had an equity pool that constituted 10.9% of the company’s total shares outstanding. Approximately 80% of that equity pool was distributed to employees, directors and other recipients, with the remainder held in reserve for future awards.

  • The near universal approach is to distribute a significant majority of that equity pool to participants at the time of the initial PE investment, with the understanding that this grant of LTIP awards would be the only grant the participants receive for the duration of the PE’s ownership. This approach is different from typical public company practices, where most companies grant new LTIP awards every year.

Equity award vehicles. While some PE portfolio companies will grant full-value stock awards in limited circumstances, a significant majority of these awards are appreciation awards. Like stock options, appreciation awards will only have value if the company’s value increases from the date of the grant.

  • Our review of recent PE-backed IPOs found that 96% of them had outstanding appreciation awards (stock options, stock appreciation rights, and/or profits interest units), while only 41% had granted unvested full-value share awards like RSUs or restricted shares. Over 90% of pre-IPO companies that granted full-value awards also granted appreciation awards, while 61% of those that granted appreciation awards granted only appreciation awards.
  • The popularity of profits interest units among PE-owned portfolio companies has increased in recent years among U.S. executives because of the potential for lower income tax rates on the gains when compared to stock options. Profits interest units are actual equity interests in the company, and require that the company be structured (or taxed) as a partnership before they can be granted. Other requirements related to holding time and tax filings must be met before the holder can pay U.S. income taxes on their earnings at the lower long-term capital gains rates.

Plan participation rates. Participation rates for equity-based LTIPs among PE-owned portfolio companies are commonly more limited than at public companies.

  • WTW’s “2021 Long-Term Incentives Policies and Practices Survey” found that, on average, U.S. companies offering long-term incentives gave awards to 3.2% of the entire employee population. This would typically include all executives (VPs and above in most companies) and a majority of senior managers.
  • For PE-owned portfolio companies, our research found that while C-suite executives are almost always included in the plan, the extent to which the company goes deeper in the organization with awards varies. In some cases, even those at lower executive levels may be excluded. As a privately-owned company, the PE sponsor is likely reluctant to share extensive information about company value with a broader group of employees.
  • It is worth noting that while public companies commonly define their LTIP awards on an expected value basis (i.e. the dollar value of the awards), the expected value or cost of LTIP awards tends to not be a factor in PE’s decisions on how to allocate their awards. Instead, most PE firms make awards as a percentage of the overall pool.
  • Cash LTIPs in place of equity grants may be offered to key employees who otherwise may have received equity awards in a public company, though the potential value of these multi-year cash plans would be capped at a maximum cost.

Vesting Requirements. While the time vesting requirements for LTIP awards at PE portfolio companies are similar to those on public company LTIP awards (three-year to four-year gradual vesting being most common), for top executives it is also common to include a performance vesting requirement. Both the time and performance vesting requirements must be achieved for the vesting restrictions to be lifted.

  • Sixty-three percent of the PE-backed portfolio company IPOs WTW reviewed disclosed they still had outstanding performance conditions on at least some of their equity awards. It is possible some companies that did not disclose performance vesting terms had forgiven the performance hurdles, or considered them achieved, prior to their IPO.
  • The financial performance vesting conditions associated with PE portfolio company LTIP awards are most commonly tied to the financial return for the PE owner, not on the value of the portfolio company itself. Therefore, it is common to find that the performance conditions cannot be fully assessed until the PE owner fully exits the company.
  • Common performance goals used by PE on its portfolio company LTIP awards include internal rate of return (IRR), multiple of invested capital (MOIC), and multiple of money (MoM).

Liquidity Opportunities. Even if the time vesting provisions on LTIP awards are achieved, participants are typically restricted in their ability to exercise stock options or sell vested shares until the PE owner exits their investment, either through an IPO or a sale of the business. If the PE owner provides an opportunity for LTIP participants to cash out of the plan before the PE exits, it is typically at times and values that they dictate.

  • Because of these restrictions on exercising options or selling shares, it is most common for LTIP recipients at PE portfolio companies to earn cash on their awards only when the company completes its IPO or is sold to a new owner.

While many PE firms prefer to adhere to LTIP plan designs that can apply to all of their respective portfolio companies, executives that are considering a PE-backed takeover can negotiate on some key provisions of the plan such as the size of the equity pool, the number of employees that will participate in the plan and the vesting provisions.

Since a large percentage of the pool is commonly allocated at the time of the investment, getting the details right up front can be a major incentive for the key employees who may be reticent to stay under new ownership.

A version of this article appeared in Workspan on August 11, 2022. All rights reserved, reprinted with permission.


Senior Director, Executive Compensation and Board Advisory (Arlington)
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Senior Director, Executive Compensation and Board Advisory (San Francisco)
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Senior Associate, Global Executive Compensation and Analysis Team (Houston)
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