How to account for management option pool with strike price in 3 statement model
So I have a modeling test and I've studied standard materials that shall not be mentioned on this website. One quirk is that the company has a 15% management equity pool with $1 strike price. I know in the materials that shall not be named, level 2, there is a % management rollover, where the returns aren't impacted because the growth on the portion of the equity that the PE firm owns is the same, but how does that $1 strike price come in to play / how do you account for that?
At the end of your LBO you look at the EV - net debt to arrive at equity value, and assuming that the this hits the $1 share price threshold (meaning Equity Value / Total shares > $1?), then in that case the 15% vests? Sorry I know this is a dumb question
Quick answer is that management gets 15% of the equity gain (not the total equity at exit). So for example, with a $50M "entry" equity check, if the ending equity value is $150M (ie. 3.0x total MOIC), then the sponsor gets $50M initial equity + $85M of gain (85% of the $100M equity gain) = $135M total ending equity value / 2.7x MOIC. The option pool dilutes the initial equity holders (assuming there is a gain).
The detailed answer as it relates to "share price" is that usually when buyouts are done, each $ invested equates to 1 "unit" in the LLC (equivalent to 1 "share" from your example). So with a $50M initial equity investment, there would be 50M units/shares at closing and the starting unit/share price is $1.00. The $1.00 strike price means that the options strike at the entry equity value / 1.0x MOIC. So they are only "in the money" if there is a gain on the equity.
so for the purposes of a 3 statement modeling test, the only nuance in accounting for the mgmt option pool is in the returns calculation?
Meaning instead of realizing the full 3x MOIC they realize the initial $50 + 85% of the $100 upside = total of $135.
$135/50 = 2.7x MOIC; and the mgmt takes home the remaining $15mn?
And to reiterate the point about the share price; $1 share per unit is the strike price, so anything above $1/unit is the 'upside' case; meaning the mgmt will only realize their share of the pool if the equity value increases during the hold period?
Thank you so much sorry if I just repeated what you said
Yes, it only matters in the return calculation. The way that I usually simply model is basically treating the cash equity investors as preferred in the waterfall. So assume they get all of their capital contributions back (and they take their pro rata share), then if there is still equity value left over, everyone get's their fully diluted portion of that including management. Because the cash investors got all of their money back, that necessitates clearing a 1.0x MOIC / $1 unit strike price.
Had my model test and they said this was exactly right. Thank you!!!
na
Amet aut et inventore dolores non repudiandae. Ut quibusdam excepturi aut iste eum. Et libero mollitia aut exercitationem deserunt excepturi quo. Vel et voluptatem quia iste labore. Excepturi commodi fuga ipsam libero placeat voluptatem voluptas repellat. Ex aut molestias quibusdam numquam adipisci dolores.
Distinctio nihil facilis aliquid autem. Voluptatem et dolorum quia est non doloremque. Dicta totam in vel nulla veritatis non possimus. Sint rerum iste exercitationem ut eos.
Magni architecto aperiam possimus nobis. Adipisci fugit nostrum minima culpa aperiam. Iusto eaque voluptatum nobis occaecati.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...