From Public to Private: Understanding PE Executive Compensation
The dynamics, priorities, and imperatives of private equity (PE) portfolio companies differ significantly from publicly traded corporations. These distinctions can manifest when PE-backed companies negotiate employment and compensation with C-suite executives. For executives considering transitioning from public companies to the PE sphere, understanding the unique issues and nuances of PE structures and their impact on compensation packages is essential.
Pre-Employment Due Diligence: What to Know Before You Sign
When executives consider opportunities at PE-owned companies or when their employer contemplates recapitalization, several pre-employment and transaction issues warrant consideration before reviewing employment agreements and ancillary documents. Beyond getting to know each other, executives need to understand the sponsor's structure, goals, and level of involvement in company management.
Once a puchase or merger agreement is being negotiated, executives should negotiate their own issues,while they still have leverage; issues that may in fact be atypical of public company arrangements, such as co-investment or "rollover" terms and equity incentive grants that represent a significant portion of the ultimate payouts at "exit."
When employment-related agreements are presented, negotiating all key terms becomes crucial—including cash compensation, benefits, termination provisions, restrictive covenants, and the impact of termination on equity grants. Having counsel and tax advisors familiar with each step helps ensure fair and equitable terms in both the short and long term.
Assessing the PE Landscape: Industry, Role, and Investment Returns
Before examining compensation package details, executives must understand the industry they're joining, their management team's role structure, and the company's and investors' goals for return on investment.
Because little public information exists about PE-backed companies (unlike public companies), those looking to lead PE-backed portfolio companies must gather information directly from sponsors and the company. Consequently, negotiation timelines are often longer as the information-gathering and interview stages take time. Importantly, executives should remember they're considering opportunities as both executives and investors.
Because investment timelines are significant (usually at least five to seven years) and ultimate payoffs come at investors' liquidity events, executives must be comfortable not only with sponsor partners but also with the management team they would join.
Board Dynamics: Understanding PE Sponsor Control and Oversight
A key corporate governance difference for portfolio company executives is board involvement and membership. While CEOs of public companies and closely held private entities often hold both chairman of the board and CEO roles, allowing more control over the company and its directors, portfolio company CEOs are often board members, but control typically lies with the PE sponsor (depending on ownership percentage).
The portfolio company's board of directors, appointed by the PE sponsor, is often much more involved and exerts far greater oversight over company strategy and executive performance. Executives should get to know prospective board members and understand whether the board will be hands-on or hands-off. Understanding the sponsor's general approach and management style throughout the investment becomes essential.
Aligning Interests: Exit Strategy and Compensation Timing
To effectively negotiate long-term compensation, executives need to understand investors' goals and how to best align respective interests. Portfolio company executives need to understand the PE sponsor's desired investment timeline and exit strategy.
Understanding where the company is in its growth stage is also important. Investor risk and interests may differ for portfolio companies representing distressed assets versus those in growth stages going through second or third funding rounds. This can result in varying amounts and types of equity compensation and investment opportunities. Understanding the anticipated liquidity event—whether a sale to another PE firm, an IPO or SPAC, or a divestiture—allows executives to negotiate vesting terms that appropriately compensate them for reaching those goals.
Therefore, executives (and their counsel) should request the capitalization table, which may provide analysis of the company's ownership percentages, equity dilution, and equity value in each investment round by founders and investors, as well as timelines or information about liquidity events. Anticipating whether and when future capital injections are forthcoming may allow executives to protect equity interests from significant dilution in later funding rounds.
When considering and negotiating the deal between themselves and PE sponsors, executives will find that the need for information and the importance of alignment and engagement are critical to their success and the success of their business. While PE companies have created a large market for talented executives, a certain level of risk and investment is necessary for successful employment relationships.