Equity comp at PE portfolio companies
I've noticed that WSO has an enormous amount of content on PE carry but limited information on equity compensation for the underlying portfolio companies and their management teams. I've been fortunate enough to be a part of two PE-backed portco exits, so I'd like to share what I've seen and then open it up for others to share any info or experiences.
For those that don't know, PE groups typically create a pool of equity in new platform investments that they provide to management teams to incentive performance. The amount of equity is typically around 10%, and this can go up or down a few percentage points based on the size of the deal (smaller deals will get larger equity pools and vice versa).
The allocation of the pool varies from deal to deal, but usually the largest chunk is given to CEO, next chunks to COO, CFO, CDO, and remaining chunks to key SVPs and VPs. Some companies choose to keep equity only with the most senior executives while others spread it down even to the manager or associate level, especially for corporate development roles that can help directly impact growth. In a typical 10% equity pool situation, I'd estimate the allocation to be 4% CEO, 1.5% each to COO/CFO/CDO, and the remaining to key SVPs and VPs in corp dev and ops, give or take 1% in each example.
Vesting is typically based on a combination of time and performance, with performance often being based on MOIC at exit. PE firms tend to push for a larger percentage to be based on performance with higher hurdles, while management teams push for a higher percentage to be based on time with lower MOIC hurdles. Based on my experience and what I've heard from others, market is 50/50 split between time and performance, with full vesting received at 5 years and 3x MOIC. I've heard of some firms pushing full performance vesting on naive management teams at 4x or even 5x with no time component, which is crazy and not something you want to agree to.
An example in action - let's say you joined a $25M EBITDA company and grew it to $100M. The company sold for 10x ($1B) and had 6x leverage, so equity of $400M. The PE group put in $125M so they had a gross MOIC of 3.2x. In our typical example from above the management team would have hit their performance hurdle so they'd be fully vested and receive 10% equity, or $40M. If you were the CFO, you would receive $6M in equity compensation (notwithstanding any rollover or co-investment). Woo hoo!
Now if the company was purchased by another PE group, you'd have the opportunity (and expectation...) to rollover a chunk of this (~50% give or take) to double down and get a second bite of the apple on the next investment. Do this 2-3 times in your career and you can make some serious coin.
Happy to answer any questions and would love to hear what others have seen in their experience.