Restaurant Chain LBO - Management Option
Hi everyone,
Hoping someone can help provide more clarity about this problem due to management options + rollover equity in one case. I've asked a question about management options before and am new to this, so please bear with me. For those with the WSO PE course, this is the "Restaurant Chain" case that was sent out separately last week. I'll round some of the numbers.
Sponsor owns 75% of the company at entry and management rolls over 25% ownership. There is a 10% "fully diluted management option" pool (exact words from case). Ending total equity value, before factoring in rollover or options, is $160 K. Initial sponsor investment was $35 K (75%). Management rollover was 11.67 (25%).
The published solution is saying to work out sponsor equity as follows:
Sponsor ownership pre-option: 160 * 75% = 120
Management ownership: 160 * 25% = 40
Management options: (160 - 35) * 10% = 12.5
Sponsor equity at closing: 120 - 12.5 = 107.5
What is not adding up to me is why (1) cash received from the option isn't being calculated, and (2) the management option is now being diluted in the capital structure. If you build a proper cap table and assume management options is 10% of the post-exercise amount (sense it indicates it is fully diluted), you get:
Sponsor: 35 K (67.5%)
Management rollover: 11.67 K (22.5%)
Management options: 5.19 K (10%) -> also the cash received from management upon exercising their option.
So in my view, sponsors own 67.5% of the company at exit, or (160 +5.19) * 67.5% = 111.5.
Just trying to get some clarity as I feel the technique used for management options changes case by case, depending on the source. Thanks very much for any guidance.
If you like to think of it starting with Fully Diluted, my approach would look like
Starting FD Cap Table:
Sponsor: 65% (seems like this is what tripped you up, mgmt shares don't look to be diluted so sponsors take full burden)
Mgmt roll: 25%
Options: 10%
Sponsor gets [65% X 160] = 104
Plus the option strike of [10% X 35] = $3.5
In total, 107.5
Thanks - makes complete sense this way! In absence of any other information, should we always assume management roll is not diluted? The dilution is just the sponsor equity?
In real life its case by case and negotiable. If a founder(s) is also "management" and they got chips off the table at sponsor's entry, they usually participate in the creation of a management incentive pot that covers all the key hires that aren't materially in the "mgmt roll".
I think in this case, management is the only definition of the non-sponsor group. So if its the same exact group of people in both at the same ownership %s, its safe to assume they aren't in a mechanism to move their money away to themselves.
still not quite grasping where the $3.5 option proceed is going. Shouldn't it be counted as part of the total exit equity and re-distributed to management pro rata?
I have the PE WSO course, but didn't receive this email? Are there case studies being sent out every week to those who have it..?
PUSH
WallStreetOasis.com any idea what's going on?
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