The common understanding of performance-based equity compensation is that if an executive leaves before a liquidity event – typically when the company is sold – they’re out of luck. They can keep whatever time-based equity they have that’s vested, but their performance-based equity goes away.
But before assuming that, equity compensation specialists say, executives should examine the terms that were negotiated when the management team’s equity pool was created. If the terms include what might be called post-termination tail eligibility, they might still be in luck if their leaving the company was on good terms.
“If there's a good-leaver termination situation, then [this benefit] would allow the performance vesting award to hang out there for some period of time,” said Joshua Gelfand, a partner with Troutman Pepper who specializes in equity compensation. “So if a transaction occurs during that tail period, it remains eligible to vest.”
Usually the tail is between six and 12 months, which means if a liquidity event occurs within that period after someone leaves, that person could participate in the event as if they were still with the company.
Not all equity pools contain terms permitting it, but private equity sponsors are becoming increasingly comfortable with the benefit, Gelfand said in a podcast hosted by Troutman Pepper.
“Depending on the situation, I've seen that [kind of benefit] negotiated where sponsors are comfortable with that,” he said. “I've seen situations where sponsors are not comfortable with that.”
The idea is that, if a liquidity event happens shortly after a person leaves, it’s likely that person played a role in the increase in equity value that’s realized in the event. “They should get the benefit to some extent of that transaction,” Gelfand said.
Michael Crumbock, a Troutman Pepper partner who also specializes in equity compensation, said he’s seen the benefit come with terms of between three and 12 months.
“I think six months is probably one of those areas where most people [on the private equity sponsor side] can be comfortable,” he said. “Managers leaving within six months of a transaction … probably were involved to some extent, and certainly were … instrumental in driving the success of the business that’s being sold.”
In a different iteration of the benefit that Crumbock has seen, although only once, the company agreed to run a pro-forma evaluation on what would have vested to the executive, assuming the liquidity event happened on the executive’s separation date.
“I thought [that] was unique,” Crumbock said. “Probably not easy to do. It's one of those situations where you're drafting it and putting it in English, but when you have to actually run that calculation, it's just probably not the cleanest calculation that you have to make.”
Gelfand said he’s seen a related type of calculation on repurchase, or call, rates. The calculation applies to executives who leave and the company has rights to repurchase their vested equity as long as they pay fair market value for the shares.
“What I have seen on occasion is management teams try to negotiate for some sort of a tail almost on the buyback, where if a transaction occurs at a higher valuation within some period of time after the termination buyback date, they'll get an adjustment upward on the repurchase price,” said Gelfand.
That kind of thing doesn't happen often but it’s something private equity sponsors have become comfortable with, he said.
Bottom line: General counsel and other members of the management team, or any employee whose compensation includes a performance-based equity component, should look at the terms that were set for the equity pool when it was created to see if it allows them to benefit from a liquidity event that occurs after they leave.
If it occurs shortly enough after they leave, they might be able to benefit from the event as if their performance equity was fully vested.
