Portfolio company option scheme
I'm with a portfolio company of a PE group, where an option scheme is launched. It´s actually more of a relaunch since there is already a program that has been going on for a while but senior management has partly changed and hence, there are some new offers being made.
Now, the question is if I should participate. As far as the development of the turnover and EBITDA of the company itself is concerned, I have no worries, and can make a reasonable judgement of my own. The difficult part is to judge how the current market conditions will affect the value of the company. What multiples would be reasonable to assume? The option price offered is based on a valuation made recently. But how reliable can such a valuation be? What reason would there be for the PE company to tilt such a valuation in one or other direction? My worry is that I am buying in on an expensive level, based on what the market looked like "before the storm". Maybe a difficult question to answer honestly for you people in the industry - but is there not a significant risk that finance professionals in the current market over-valuate portfolios, not wanting to see the truth?
I guess that looking at recent transactions would be a way to go but when you´re not working with this on a daily basis you dont really know. And in any case I guess only transactions in the last, say two-three months would give some guidance. What multiples are actually being paid in various markets and industries in the last couple of months? The company is based in Europe. Time horizon three-four years. Thankful for insights from you guys who battle these problems regularly.
you're asking the right types of questions here but unless you give us more detail on the industry and financial history of the firm, as well as what valuation the options are being valued at it is going to be hard if not impossible to give you an opinion.
might also be wise to take your cue from senior management. Is the CFO buying these options (make sure they are the same ones and not a lower valuation)?
also, do you have enough cash right now to afford these options. How long before they vest?
I completely grazed over this post but I think it's probably one of the best ones posted in a while. Very valid questions being asked here. Generally speaking, if your company was valued recently it probably is being valued at a low in terms of equity value. That means in terms of your options, the strike price being set at a fairly low value. If you're confident in the business model and the long term value creation, then I would definitely research the comps, historical trading, past transaction multiples, etc. to get a view on where your valuation multiple stands relative.
Make sure that the members of management that are in your pre-existing option plan are buying additional shares at the new valuation and not demanding that their existing options be repriced at the new strike price, which could potentially dilute you. We've been seeing management of our portco's requesting that their options be repriced bcause they are at an unrealistic strike price relative to today's valuation (and realistic future value creation expectations). Sometimes we oblige because it helps keep management incentivized, but be aware that this could happen to you.
We usually structure our options as a portion time vesting (with acceleration upon change of control), portion performance vesting, and a portion cash-on-cash multiple of money delivered to sponsor dependant (or IRR dependant). Hope that helps a little - additional questions welcomed.
Thanks for the replies. Some further clarifications: The offer is based on the old option plan. That plan is well in the money. That means that the current offer requires putting quite a lot on the table to purchase the options, since if they should vest now (i.e. change of control) the strike price would be significantly lower than the stock price. Without change of control there is no vesting within a couple of years. But for late-joiners it almost becomes like buying (illiquid) equity. The risk that the stock price would fall below strike price is in my opinion negligible. The strike price increases over time, but that is the only thing factored in.
I don´t think this is a very attractive set-up, mainly due to the lack of leverage that follows. I don't see any participants in the old plan purchasing more options now, since it's a much worse deal. It becomes more like buying some unlisted stock. That could still be attractive, but very much depends on the valuation of course (hence the valuation concern). Would you consider this to be a standard set up, or would a more common approach be creating a new option plan with a higher strike price? It is also a bit strange since the whole point is to give incentives, but with such a plan I just don't see that effect.
Can someone kindly direct me to a source where I can learn about PE companies & options on their portfolio co's? I worked on an option-related project as a PE intern, but need a better understanding for FT interviews.
It would be a HUGE help...thanks anyone. FYI, the project involved an independent valuation of the portfolio co., and somehow the valuation was relevant to how the PE firm handled options on the portfolio co.
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