With declining equity market, private equity firms have started to more heavily look for opportunities to take public companies private. As of June 30, 2022, there have been more than 27 go private transactions in the United States in 2022. This compares to 47 go private transactions in the United States in 2021.
A go-private transaction places the chief executive officer and other senior management of a public company in an unusual situation. They cannot purely function in the normal manner of running the company, subject only to the overall direction of the Board of Directors. In going-private transactions, the Board of Directors exercises control over the sales process and often increased control over business decisions until the transaction closes. In addition, there can be more scrutiny from activists and other institutional public equity investors and there is more concern on the part of employees and even management as to what all of this will mean for their jobs and their income.
Go private transactions evolve in different manners. These range from the Board deciding to sell and proactively marketing the company, to activist investors pushing the Board to sell, to receiving unsolicited offers from strategics or private equity buyers that cause the Board to evaluate options. All of them put new obligations and pressures on the chief executive officer and his management team.
In most situations, the Board of Directors will appoint a Special Committee to examine alternatives and report back to the full Board, although on occasion the Board will act as a committee of the whole (absent the chief executive officer). The Special Committee will control the transaction process and it will determine the level of involvement of the chief executive officer in the negotiation process. Even if the chief executive officer is involved in the process, he generally will not be able to discuss compensation issues for him or her and his or her team during the negotiation process, although he or she often will get indications of whether the intent is to keep the management team.
A key requirement of the proxy form that needs to be distributed to obtain shareholder approval includes a full description and disclosure of any commitments to management on compensation, structure of equity plans or other benefits negotiated with potential buyers. To avoid the latter from becoming a basis of plaintiff lawyers challenging the fairness of the deal, most compensation and new equity terms discussions are delayed to after the shareholders have voted on the transaction and, in some cases, until after the go private transaction is completed.
When retention of the chief executive officer is critical to the acquisition decision, the negotiations with the chief executive officer is conducted after the Special Committee has agreed on price with the potential buyer to avoid the allegation that what the chief executive officer is receiving impacted the price being paid to shareholders. The terms of the new compensation and equity plans will be agreed and disclosed to shareholders as part of the transaction approval process.
This timing, especially if discussions must await the shareholder vote, leaves the chief executive officer and his or her senior team in a state of suspended animation as to their future. While usually the vesting conditions with existing compensation and equity plans will create economic incentive to stay through the closing and perhaps a limited period thereafter or a retention award is established, management does not know how attractive the new private equity structured equity arrangement will be for them or what incentive vehicles they will have to retain their team going forward.
If the existing management is staying on, there is likely to be a coordinated negotiation of the new equity incentive plan and other compensation issues through the continuing chief executive officer at the appropriate time. If a new chief executive officer is contemplated by the buyer after closing, the design of the future plan for senior management will be heavily controlled by what deal the new chief executive officer negotiates for himself or herself because it is rare for any executive to get a better deal than the chief executive officer.
Steps can be taken to help alleviate the tension and expedite the smooth transition from public ownership to private ownership. Jamieson has worked on many go-private transactions. In our experience the key to a smooth go private transaction is the planning, education and flexibility (and attention) of the acquiring private equity firm.
One of the key factors is managing team expectations. Most public company executives are not familiar with traditional private equity compensation arrangements. The trade off between a public company annual award with market liquidity versus an upfront one time grant and lack of liquidity until the private equity buyer exits is stark and foreign to public company executive teams. It is very important to start to educate the senior management team as early as possible after the merger announcement as to what to expect in the new private company environment.
As a starter for preparation, it is important that there is clarity on the treatment of current compensation arrangements as part of the transaction, for example acceleration of unvested awards which are then used as a reinvestment tool into the go private vehicle. Reinvestment is a key requirement of private equity and one of the most common issues is the lack of proceeds from which management teams can reinvest. Treatment of existing equity is usually negotiated as part of the merger agreement. So it is known, but it needs to be taken into consideration in any discussion of reinvestment.
Another early step that needs to be taken is a focus on how deep the new equity plan developed by the private equity buyer is going to be allocated and what substitutes will need to be used at lower levels to replace the lost compensation. The buyer may give some indication early on regarding the size of pool it is contemplating and its thoughts on the depth of grants. As noted above, the grants in a public company are generally granted to lower levels then in private equity owned companies. This is not necessarily bad, just different. Often at lower levels, the grants are not appreciated and cash will have more impact. But lost compensation elements not made up in some manner (even if not previously appreciated) will have a negative impact on employees. It should also be noted that cash plans will have a negative impact on earnings and, therefore, the preference of private equity to use equity plans over cash awards. Design of new alternatives should start as soon as possible as blueprints for how to retain existing talent and attract new talent over the next period of private ownership.
The private equity firm taking the company private will have considered the size and design of its desired pool at the time of making and negotiating its offer for the Company since it will impact its return analysis. There may, however, be some flexibility in the size of the pool, the vesting at different levels and the details of the plan. Management needs to be prepared with its own analysis of how the pool should be allocated and what returns are reasonable for management considering the additional risk and lack of liquidity in the private equity setting. It may be that the sponsor has different ideas on these issues then management and these need to be rapidly discussed and negotiated.
It is important for the chief executive officer to present his or her view of the allocation of the equity grant among his top team. Often it is as simple as applying the relative grant levels that existed in the public annual grants to the new plan, but sometimes it is more complicated. This is a one-time grant and, while in the public company grant adjustments can be made year-to-year, in a private equity environment grant value for the next five years generally needs to be considered up front (although top up grants are often given if promotions are made). The transaction, however, gives the chief executive officer the ability to think through the relative importance of roles that his various team members provide and their relative importance in a private scenario as opposed to a public one.
Once the permitted negotiation date occurs, the speed of the negotiations will often depend on whether there is going to be “skin in the game” required of management and whether it is going to be done through a tax-free rollover of existing equity or by an after-tax investment (and whether there is any accelerated unvested awards that can be rolled into the new go private vehicle). Any tax-free rollover must be agreed on pre-closing and implemented at closing, while after-tax investment is not sensitive to the same timing issues. If an executive is going to agree to rollover equity (including if a buyer wants that commitment as part of the initial negotiations), he or she will usually want a simultaneous commitment on the incentive plan. In addition, in all cases there is the issue of trying to assure that management’s equity and incentives are issued at the same value as the private equity investment. Lengthy differences in timing can raise tax and other issues. However, perhaps the most important concern is to put the compensation issues and its distractions in the past and focus on the new company going forward. Therefore, it is in everyone’s best interest to expedite resolution of issues.
But equally important is spending the time to negotiate the detailed terms of the plan, including what is the contemplated timeline to exit and form of exit, whether vesting will be measured only on cash realization or also value realization, treatment of leavers, including rights to purchase a leavers shares, and a series of other issues that go to the core of what management is signing up to.
There will be tremendous pressure to rapidly resolve these issues for the reasons stated above. Therefore, it is important for management to identify the issues early and be ready to resolve them as soon as the private equity firm is able and willing to discuss them. This means identifying, retaining and working with specialist advisors as early as possible in the process, as even if the new terms of the plan cannot be negotiated before closing, being prepared to discuss them ensures a smoother process of transition and better outcome for management teams.
Jamieson Corporate Finance US, LLC is a member of FINRA/SIPC