“Losing an illusion makes you wiser than finding a truth.”
– Ludwig Börne
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A. The Basics of Private Equity Strategy: Most Private Equity business strategies can be summed up as: (a) purchase of an ongoing enterprise into the P.E. Firm’s portfolio companies (b) largely with investor and borrowed monies (c) to be owned on a rather short-term basis, (d) at reduced overhead, (e) other than management fees to the P.E. Firm, (f) to then sell the portfolio company (g) distribute the gains (that is, “slice the cake”) among (i) the P.E. Firm and its Members, (ii) secondarily to the P.E. Company’s investors, and (iii) hopefully, too, among the P.E. Portfolio Company’s Employees.
B. The Basics of P.E Employment and Its “Tiered” Documents: For four decades we have represented executives, managers and other employees (“P.E. Employees”) in their Private Equity Portfolio (“P.E. Portfolio”) employment negotiations. It is a highly orchestrated process. While the documents and dynamics reflect the particular businesses and industry of the P.E. Portfolio-Employer, there is also a “norm of nomenclature and negotiation” in P.E. Portfolio employment negotiation.
C. The Cake and How it is “Sliced”: Over the years we have developed a visual metaphor for P.E. Portfolio Employment Documents and Negotiation: a 3-tiered cake, with glowing candles on top:
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- Bottom Tier (#3) of the “Cake”: The Usual Employment Agreements. As expected, P.E. Employees are required to sign customary documents that set down the terms and conditions of the employment relation: (i) employment contract, perhaps, too, (ii) restrictive covenants agreement, (iii) bonus agreement, (iv) benefit plans, etc.
For the P.E. Portfolio Employer the agreements’ purposes are to (a) engage those Employees needed to operate and grow the enterprise, and (b) retain those Employees until the P.E. portfolio company is re-sold to others – generally a new P.E. Firm and its new investors, sometimes on a public exchange (either, an “Exit”). It is nearly universal that the P.E. Firm and its investors seek the bulk of their rewards upon re-sale and Exit, commonly only three to seven years after purchase.
On this subject, you may want to read an article we published years ago entitled “Private Equity Buying Your Employer? Resist these 11 Employment Negotiation Tactics.” To do so, just [Click Here] - Middle Tier (#2) of the “Cake”: Equity (and/or other long-term) “Grant” or “Award” Agreements: In essence, these are (i) promises (“Grant Agreements”) of long-term employee incentives that earned and come due upon Exit, with (ii) a set of “rules” for eligibility, vesting and distribution. Essentially, (1) Come and stay on Board, (2) Until we Exit, and (3) You will receive a substantial “Slice of the Cake.”
The Middle Tier’s purposes are twofold: (i) to attract and retain Employees with the allure of outsized financial rewards for their efforts and loyalty until Exit, yet (ii) to provide “safe legal distance” and “buffer from commitment” between (a) the “Promisor” P.E. Firm and (b) the “Promisee” P.E. employees.
This “buffer from commitment” is accomplished by provisions that permit “legal avoidance” of promised Rewards to employees, for example, (i) that Plan “Rules” can be changed without employees’ consent or knowledge. And, too, (ii) the Employment Agreement makes no mention of this “Second Tier” set of significant promises with “commitment buffers.” Significantly, these Tier 2 documents may (a) determine what, if any, of the “Cake” ever get “served” to the employees, yet (b) not be available for negotiation, even review, until after Tier 3 documents are signed. - Top Tier (#1) of the “Cake”: the P.E. Firm’s Shareholder, LLC, or Operating Agreement. Though this overriding Agreement permits dilution and denial of promised “Exit Rewards,” frequently they are never provided for review, and never for negotiation; to which the Employee is not a voting member, but to which he or she is commonly required to subject himself or herself to the decisions made – and to be made – by the P.E. Firm.
The purpose of the “Top Tier 1” documents is to enable the P.E. Firm to control, oversee and manage the entire endeavor and most importantly “Slice” and distribute the Cake. The largest “slices” possible are reserved to themselves, and to their investors, the least, if at all, to the Employees.
- Bottom Tier (#3) of the “Cake”: The Usual Employment Agreements. As expected, P.E. Employees are required to sign customary documents that set down the terms and conditions of the employment relation: (i) employment contract, perhaps, too, (ii) restrictive covenants agreement, (iii) bonus agreement, (iv) benefit plans, etc.
What about the “Candles Aglow at the Top?” As with all candles at the top of all cakes, these are not for “consumption” but merely “allure.” By “Candles Aglow” we refer to Marketing Materials, prepared for distribution to prospective Investors and to attract, retain and motivate highly qualified Employees. They frequently include rather “optimistic” Financial Projections, Industry Trend Analyses and “Expert Opinions.” Note the “smoke signals” tactically labelled “Non-Binding” or “For Illustration Only” inserted throughout the “Glowing Candles” at the insistence of the lawyers.
Their purpose is to grab and hold onto the imagination of their readers – particularly prospective Investors and key Employees, and to encourage their entry into, and continued loyal participation in, the P.E. Firm’s endeavor. (This is the proverbial “Shiney Object,” the thing that “captures” the imagination, and holds on to it.)
Coming Soon: Private Equity Employment:
How to “Slice” the “Cake” Your Way
In upcoming Newsletters, we will address (a) Steps to Take If Offered Employment for a Private Equity Portfolio Company, and (b) “How Can I Ensure I Get My “Fair Slice” of the Private Equity “Cake?”
In a world economy increasingly owned and operated by Private Equity Firms – whether in the industries of Health Care, Hot Tubs or Horror Movies – sooner or later you will likely be facing these issues.
In Summary . . .
Those presented with an employment opportunity with a Private Equity-owned (or to-be-owned) enterprise will likely be presented, in the documents to be signed, both (a) significant financial opportunity and (b) significant risks in those same documents that are not at all easy to identify or counteract. The opportunity is likely real, the offered rewards are often quite large, but so, too, are the risks to finances and career.
Understanding the process, the dynamics and the documents that need to be reviewed, signed and honored in Private Equity Portfolio employment are not your typical “Please review my contract” challenge. Rather, it is something of a triple-layered combination of (i) “If it seems too good to be true, it is,” (ii) “Look before you leap”, and (iii) “He who hesitates is lost.”
Very few attorneys are experienced in the critically necessary review, analysis and negotiation. We are, and are available to assist by telephone consultation, Zoom meeting, or direct representation.
“If you live your life the right way, your later years are not a winter.
Instead, they are a harvest.”
Upcoming Newsletters – Also Coming Soon . . .
- Bankruptcy and Employment Contracts – What Happens?
- Observed Wrongdoing at Work? – What to Do
- Workplace Dispute? – HR is Not Your “Protector”
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