Private Equity: Comp Upon Liquidity

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Because that’s where the money is.”

– Willie Sutton, famed Bank Robber,
  Explaining Why He Robbed Banks

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ACTUAL CASE HISTORIES: A significant migration is taking place among executives: from publicly owned employers to Private Equity portfolio employers. The attraction is “Because that’s where the money is,” or, to be more precise, “where the money might be.” While many of our clients have found significant financial rewards working for Private Equity-owned employers, others have met with disappointment. How do we account for the difference?: according to those who recognize – and those who do not – that alignment of strategies and goals is essential in Private Equity ventures, and in Private Equity employment, as well. 

First, let’s take strategies: The Private Equity business strategy leans heavily toward relatively short-term ownership, anticipated to last a mere three to seven years. The model is to (1) buy, (2) reinvent / revitalize, and then (3) sell. Achieving outsized ROI within shorter term horizons often entails acute and recurrent cost-containment measures, including periodic rounds of layoffs, benefit reductions, and frequent reorganizations. Those who expect regular “market” compensation upgrades are sorely disappointed, as the strategy, itself, depends on just the opposite: keeping costs lower.  

Second, let’s take goals: While Private Equity sponsors may receive hefty management fees, and investors may receive dividends, the Private Equity model’s true payoffs come upon departure from the venture. For the sponsor and investors, it is upon liquidity events of sale, IPO, merger and the like, when the “real money” is made. Alignment of goals requires that executives follow suit: to “survive” until liquidity events take place, and upon likely departure to receive the bulk of what they have come for. Like entrepreneurs, early times are “slim,” and the “fat” times only come later. Thus, alignment of goals of sponsors investors and executive employees are deemed the best recipe for success.

LESSON TO LEARN: The most common negotiation of executive employment has had a binary model of (1) commitment of the executive’s services to an employer for an extended period, in exchange for (2) the rewards of salary, benefits, annual incentives and deferred long-term retention measures, anticipated to improve over time. Employment is a somewhat “committed” relation, where both parties generally seek, intend, pursue, and reward long-term relations. 

In the newer, Private Equity “investor paradigm,” the typical negotiation of executive employment involves (a) commitment of the executive’s services not in terms of time, but rather in terms of co-investment (aka “Skin in the Game”) in return for (b) diminished salary, benefits and incentives, in (c) pursuit of potential sharing in the departure-focused financial goals of the investors. In financial terms and even vocabulary, it’s a whole lot closer to “co-investment,” an element of which sponsors, investors and executives are all “aligned” in their pursuit of Return on Investment (aka, “ROI”) in negotiation, in execution, and in payout upon departure.

As investors are lured by Return On Investment, largely upon exit (that is, contemplated “liquidity events”), so, too, are executives presented with that same inducement for their efforts and loyalty. In relational terms, it’s a whole lot closer to joint venturers than the traditional employment paradigm.  

As goals of the parties – whether sponsor, investor or executive – are largely departure-focused, so too must the negotiations proceed with those goals in mind, to adapt to this “new alignment” of (i) Goals, (ii) Timeframes, and (ii) Mitigating Risks to all. In the public-employment model, vesting of rewards is time-based. In Private Equity employment, “vesting” is a matter of performance. All considerations, discussions and negotiations must reflect – and the parties must appreciate – that distinction.

WHAT YOU CAN DO: Consider these seven (7) thoughts, which are simply illustrative, and not comprehensive:

1. Don’t Get Too “Pumped Up” by “Projections,” “Forecasts” and “Scenarios.” Private Equity investments are “sold” to investors on the basis of projections, forecasts and scenarios that are quite often overly optimistic. The “small print” is clear that these cannot be relied upon. But when this same “small print” is transmitted to job candidates, the “small print” is sometimes too “small” to make a lasting impression upon an eager mind, most especially when interviewing and negotiating. Simply put, don’t rely on sales-oriented materials.

2. We are often asked, “What is ‘Market’ for this position?” As a general rule, we have little, if any, confidence in the concept of “market” in Private Equity employment. Rather, what counts is a Hiring Manager’s perception of a job candidate as a “likely enhancer” of (i) Revenues, (ii) Relations, and (iii) company Reputation. Those are the true determinants of that candidate’s leverage. In Private Equity employment this is intensified, given the focus on performance over the shorter-term horizon.

Others’ perception of you as someone who is well known in the industry, a proven “closer” and a true “team player” are especially attractive to Private Equity employers. Don’t ask for too much or negotiate too often or aggressively, as being viewed as “high maintenance” in this context is surely and deeply negative. You want to stay with this employer just long enough to create substantial success, and to enjoy the substantial rewards of that success.

3. Wise Navigators in this Context Seek (a) Growth in Responsibility, (b) Internal Visibility, and (c) Objective Metrics of Performance. Why? Because in the Private Equity context, that’s what drives both compensation and job security. In any enterprise that is decidedly dedicated to ROI, those with proven success in important functions are what translate to both (i) likely longevity in the midst of multiple rounds of layoffs, (ii) likely candidacy for promotions over time, and (iii) likely leverage for discussions when the “big money” decisions are made: near or upon liquidity events.

Bear in mind, too, that Private Equity sponsors are always on the lookout for those who represent invaluable Human Capital to “take with them” to their next Private Equity venture, and so tend to reward these employees more handsomely than others.

4. Pay Close Attention to (a) Definitions of “Cause” for Termination, (b) “Good Reason” for Resignation, and (c) Degrees of Employer Discretion in Both. As noted above, in Private Equity employment, the most significant rewards come “at the end,” that is, upon “liquidity events.” One offer letter we recently reviewed for a client defined “Cause” for Termination as “performance below Employer’s anticipation, in its sole and absolute discretion.” On this basis, she could be terminated just days prior to the company’s sale, and lose all of her outstanding equity grants.

In negotiation, we managed to get the employer to change “in its sole and absolute discretion” to “in its reasonable discretion,” which gave her significant protection from loss, as “reasonable discretion” equates to “potential accountability,” and that equates with “risk” to the employer.

5. Depending on Company Growth Stage, Seek Dilution Protection during Later Investment Rounds. Employers that are, or will likely be, in need of further infusions of capital will likely need to issue additional shares and/or new classes of shares, units or other forms of equity. These infusions can easily be dilutive of the value ascribed to your own equity holdings. Seeking dilution protection is important, the two most commonly granted forms being (a) resets of award grants upon specified dilution levels, and (b) ensuring your equity is treated as to dilution to those of a specified management classes.

6. Expect Vesting of Contingent Interests Not Over Time, but upon Liquidity Events. The more commonplace notion of vesting over time, nearly universal in public company employment, is more often than not replaced in Private Equity employment by achievement of Liquidity Events. Whether it’s a form of equity, a carried interest, participation in special distributions or otherwise, it’s Liquidity that reigns supreme.

7. Anticipate, too, Possible Pressure to Co-Invest and Re-Invest. In the event you have accumulated equity from an employer that has been purchased by a Private Equity sponsor, you can anticipate pressure to roll over your thusly-earned equity interests, and to waive rights to “cash out.” Buying into your Private Equity employer gives you “Skin in the Game,” and a very valid argument to be treated no less favorably than, or on a near par with, other “participants.” While it raises the stakes of your participation, it like enhances your potential rewards, too.

In Summary . . .

There’s been a stampede of sorts of public company executives headed out the door, and to the Private Equity world. And, too, we are seeing Private Equity concepts and perspectives increasingly appearing in Public Company employment negotiations. Be prepared for this new paradigm, as it is coming your way, if not today, then tomorrow.

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SkloverWorkingWisdom™ emphasizes smart negotiating – and navigating – for yourself at work. Negotiation and navigation of work and career issues requires that you think “out of the box,” and build value and avoid risks at every point in your career. We strive to help you understand what is commonly before you – traps and pitfalls, included – and to avoid the likely bumps in the road. Being on the lookout for, knowledgeable about, and prepared for the new Private Equity executive employment model is essential. “The times, they are a’changing.”

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*A note about our Actual Case Histories: In order to preserve client confidences, and protect client identities, we alter certain facts, including the name, age, gender, position, date, geographical location, and industry of our clients. The essential facts, the point illustrated and the lesson to be learned, remain actual.

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