I've been presented an offer from a small PE group to run a new business. I have an MBA but private equity isn't my background, so some of the terminology and options on the table are a little over my head. They've essentially offered a very respectable salary and 5% of the company. They then proceeded to tell me that if I'd like to consider options, they're willing to give up more of the company if I'm willing to trade some salary... or if I want to propose a more creative vesting schedule using cash on cash multiples they're open to it.
If helpful, background is $1,000,000 put in by PE group to start the company (recognize this is more venture capital but they are a PE group). They own 51%. Another operating partner own 30%. I would own 5%. The remaining equity pool is going to be used to attract people to work for the company.
Where would I start? I'm certainly open to trade some salary and finding options to increase equity hitting KPIs and returning cash multiples. But is there a rule of thumb here (like 2 and 20) for vesting schedules at certain cash multiples? Any resources to point me to to help ensure I work out a fair deal?
Usually I've seen this type of vesting schedule tied to the same hurdles the sponsor probably has for their carry
Somewhere in the range of 1.50 - 1.75x for the first hurdle and 2.25 - 2.5-x for the second but this can drastically change depending on the market and firm/LPs/etc.
Is the first 5% straight equity that you get fully off the bat or is it also in the forms of options on a vesting schedule?
The sponsor should be able to give you a quick estimate of the earnings needed to hit their MOIC multiples and your estimated equity payouts at those levels. Which you can then personally risk-weight to see how much current salary you'd be willing to give up for that option (pun intended)
Thanks for the response.
The 5% is currently straight equity, vested after the original capital is returned and over the first 4 years.
The sponsor has essentially put it on me to offer up something with multiples and equity levels if I want to be more creative and tie it to KPIs and multiples. I asked the preferred rate and sponsor said they think a cash on cash multiple is a better approach and a bit simpler.
My current concern with giving up salary in exchange for equity is the stage of company. This is an early stage company, not one I can even value based on cash flows (there are hardly any to speak of), and there aren't assets. Then, secondarily, I'm not well versed on plans that tie equity bumps to cash multiples, so the odds I propose something that is ridiculous isn't zero.
Follow up question... are equity bumps usually "taken" from the sponsor? The other operating partner expressed concern that if I have a plan that bumps my equity at certain cash multiples, he understood that to mean it'd come from his share and the sponsor's share remained 50% no matter what. My understanding was sponsors give up some equity at the predefined performance metrics. Am I wrong?
It seems like a strange request that they'd ask you for cash multiples for vesting. As I mentioned, the most common approach is that performance vesting is tied to the same hurdles that the sponsor has to earn their promote so everyone is 100% aligned.
How was the business valued when the sponsor bought it? How will it be valued when you exit? The key here is to figure out how much the equity is potentially worth and how much current salary you'd be willing to give up to potentially get that equity payout in the future.
You can make a simple spreadsheet that runs this analysis at different exit enterprise values ("EV"s):
Est. EV at Close Less: Net Debt at Close Less: Closing Deal Costs Plus: Total Option Proceeds (outstanding in the money options * strike price) = equity value
Take your potential diluted equity % * the equity value to get your potential payout. Then you can also figure out the sponsor's cash multiple by their diluted equity % * equity / $1.0mm for the cash multiples at the different payout thresholds.
The equity/options are usually allocated by the company so all shareholders are diluted pro rata as a result.
This is very, very helpful. Thanks for your feedback. Additionally, acknowledged about the first part of the note... I can't find any of my friends in the PE space that have ever said, "Hey, we have an offer, salary and equity, to run this business. But btw, feel free to come back to us with a tiered vesting schedule based on performance, particularly in this very new business with no predictable cash flows."
Appreciate the input and time you took.
I don't really want to comment on your comp but if tradition PE firm all of sudden wants to dabble in VC, I'd run.
This has crossed my mind as well. I understand the approach and that some things are opportunistic (the other operating partner has very extensive experience in the industry), but this did strike me as odd. Additionally, the early stage of the company and lack of predictable cash flows just makes it even more difficult to propose something on the comp side. Thanks for the note.
Whiskey5 I don't know, I've seen a number of times where established PE shops will 'seed' (used in the sense of 'launch a new business') an idea and pedigreed operator with resources to experiment with an idea.
That's very different from VC; they're not evaluating inbound pitches for seed (used in the sense of 'operating for x-months on personal/angel capital and now talking to established venture firms for their first institutional round') stage startups and trying to invest outside of their competency.
//
Raymond-Green From everything you've shared, I think the headache you will incur trying to optimize for marginally greater comp through a vesting schedule is time poorly spent. Your energy would be better spent negotiating higher equity than 5%.
It's clear that the operating partner (30% ownership guy) is going to be the CEO, or at least he damn well better be for an allocation 6x yours. I assume you get some kind of COO or SVP type title. From my experience, 14% is slightly on the high side as a pool to divide among further non-executive hires. The sponsor (or operating partner, if he has the autonomy) should really be trying to win people with cash offers, not equity. This tells you a lot about how they think about the business; someone willing to trade away equity easily is letting you know how they think about its future value.
If they really value you, I don't see why you can't open a negotiation around raising your equity block. Don't even try to trade salary for it. That is a separate negotiation. The first one is around how much equity you're worth. Your logic should follow 'co-founder' allocations in situations like these.
Putting on my venture hat, I can tell you that there's always a leader out of a team of however many co-founders are presenting an idea (this shows up either formally through the cap table or informally through animal dynamics, you can always see who's leading the pack in behavior). If there isn't, a smart investor runs away - if there isn't anyone where the buck stops, you're leaving room for disaster to strike.
The question is how disparate is the ownership that 'leader' has relative to the other co-founders. In this case, this isn't a venture deal, but a lot of the logic holds. Is this operating partner truly worth 6x as much to the company's success as you are? Don't be bashful. You aren't attacking him. You think his allocation is fair; it's yours that you want to talk about. Yours needs to rise, this isn't about lowering his. The 'give' comes from the yet-unallocated pool.
I'd ask for either 15% or 10% outright. Try to do your homework on founder allocations or similar PE-incubated businesses for comps.
Separately, after you finish that entire negotiation and (hopefully) have a higher allocation than 5%, you can open a second phase where you discuss trading salary for equity. You should propose a table where $x = %y. Make whatever adjustments are necessary based on your dialogue with them, then offer however many dollars you're willing to give up but are now confident of exactly what you'll be getting in return thanks to your rubric.
Or, if you're very happy with your shiny new (hypothetical) 10%, skip the second phase and soak in the glow of your increased ownership.
This perspective really makes me think, both in terms of the pool we are using to lure people in and my equity pool relative to expectation with respect to who is running the business. I'll sleep on it, probably discuss with the sponsors, and follow up. Appreciate the time.
I wanted to close the loop on this, particularly since you took the time to write a great response. I did go back to the sponsors and was actually able to negotiate an even split with the primary operating partner - even salary and equity. So, massive thanks for giving me your perspective.
That said, before agreements were signed, I jumped in [without leaving what I'm doing now] and started operating and working with the partner. And what I found concerned me enough that I rescinded accepting the offer. Without disparaging anyone, it wasn't the right fit and I think the likelihood of success is very low given all the internal dynamics and my brief experiences with the venture.
I do appreciate the help a great deal.
Wow interesting turn of events.
Facere adipisci consectetur eius sit. Eius excepturi eos et facilis eos deserunt qui.
Rerum corporis minima vel officiis officia temporibus similique. Nulla magni nulla ipsa delectus est quae et voluptas. Laboriosam repellat et facere nemo blanditiis. Voluptate aspernatur numquam quis velit sequi mollitia inventore. Expedita corrupti nisi debitis unde repellat quos corporis commodi. Minus possimus repellendus velit tempore ut error. Veniam dolorem non saepe laboriosam consectetur commodi est.
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...