Probably the most important consideration for administration in any PE transaction is administration’s participation in firm development by means of exit by way of fairness. Administration typically participates in such development in two methods: rollover and/or incentive fairness. Rollover fairness constitutes an financial funding within the firm alongside the PE sponsor, which can be required—or optionally available—generally at ranges of fifty p.c or extra of administration deal proceeds. Incentive fairness constitutes an “funding” of arduous work (“sweat”) earned primarily based on time and efficiency of the manager by means of an accepted pool of fairness (e.g., 10 p.c). Every kind of fairness has distinctive concerns, whether or not company, tax or compensatory, and thus must be duly analyzed by administration and competent, skilled authorized counsel for administration (as in comparison with firm or vendor counsel) to make sure that an equitable and aggressive set of phrases and situations applies to each rollover and incentive fairness.
Rollover: Since rollover fairness, or invested money, is an precise funding in a portfolio firm and will represent doubtlessly tens of millions of {dollars} and important parts of people’ web price, administration ought to attempt to be handled on phrases considerably much like different buyers, together with the PE sponsor (e.g., pari passu). In consequence, understanding the phrases of the PE sponsor’s funding is vital.
For instance, is the sponsor receiving widespread or most popular fairness with a liquidation desire? What a few most popular charge of return? What governance rights does the sponsor possess with its funding? What are its board, info and entry rights?
Administration can be clever to grasp the PE sponsor’s funding phrases to make an knowledgeable resolution concerning the economics for its funding, together with rights and restrictions relevant to administration’s rollover funding. That mentioned, administration, as service suppliers, differs of their function relative to a pure investor, and extra concerns are current.
Relatedly, is rollover fairness being made topic to vesting, forfeiture or different punitive repurchase rights on sure occasions? What occurs when employment terminates or loss of life happens? Are restrictive covenants tied to rollover fairness? Administration counsel ought to establish the sponsor’s rights and restrictions and advise administration on its funding and rights (e.g., liquidity) and restrictions which will (or ought to) apply to its funding. These, along with the tax effectivity, are typically probably the most key concerns in rollover fairness analyses by administration counsel.
Incentive: Distinct from rollover fairness is administration’s participation in future development by way of incentive fairness. Incentive fairness phrases, together with definitions, taxation (strange revenue vs. capital beneficial properties) and vesting, are closely negotiated and significant to administration.
What measurement is the fairness pool and when, by whom and the way is it allotted? What are the vesting phrases (each time and efficiency), what portion is tied to efficiency, and the way is efficiency measured and outlined? What occurs upon termination of service, whether or not voluntary or involuntary? Is vesting accelerated upon a change in management? Whereas these are distinctive points relevant to incentive fairness, most of the rollover fairness concerns may additionally apply to incentive fairness—for instance, liquidity and taking part when the sponsor participates.
Administration Counsel: If concerned on the early phases of a transaction (even earlier than the corporate is marketed), administration counsel can take level or experience shotgun to administration and advise administration what to search for, what to ask and the way and what to relay to potential suitors for the enterprise when administration’s roadshow and follow-on discussions happen. Not being armed with correct market perspective and key info has proved detrimental to administration.
Given the tax and company complexities, along with the varied vesting and forfeiture concerns for administration, profitable administration groups have reaped rewards by partaking stand-alone administration counsel to teach and signify administration in these complicated areas, and primarily advocate for administration within the transaction area. Failure to interact administration counsel places administration within the precarious place of falling into pitfalls that might have been prevented or managed.
