Key Takeaways:
- After an acquisition, equity compensation plans frequently undergo a transition to line with the new ownership goals.
- Key leadership talent can be attracted and retained with the support of well-structured incentives.
- Accurate valuation ensures compliance with ASC 718 and IRC 409A, enabling proper expense recognition for equity awards and avoiding adverse tax consequences.
Navigating Equity Compensation Post-Acquisition
Many companies’ strategic plans change significantly post-acquisition. There are numerous reasons, including the new owners’ goals and objectives, potential changes in executive management, changes in the composition of the Board of Directors, strategic fit with a Private Equity buyer’s other portfolio companies, and others. With these evolving priorities, organizations must reassess their compensation structures—particularly equity incentives—to retain and attract top talent.
Building for Future Growth
The acquisition (or change of control transaction) often results in additional capital available to the acquired company. As part of the growth plan, many organizations will also add new members to their senior management team, or to their board of directors. To attract and incentivize these individuals, many organizations will issue some form of equity compensation, ensuring that these individuals will share in the future growth in value of the organization.
Types of Equity Incentives
Equity incentives come in various forms, all designed to align leadership interests with company performance.
One of the most common approaches—used by both private and public companies—is time-vested stock options. These grants give employees the ability to purchase shares at a predetermined price (the strike price). This structure rewards both tenures, as employees must stay with the company to vest their options, and stock appreciation, since the value of the options increases if the company’s stock price rises.
Public companies find stock options particularly attractive because their shares have a liquid market. This liquidity makes it easier for employees to exercise their options and realize financial gains.
In private equity-backed businesses, equity incentives are often tied to financial performance milestones or exit strategies.
For instance, a management incentive unit might vest only if the company surpasses earnings before interest, taxes, depreciation, and amortization (EBITDA) targets over a three- to five-year period. This approach ensures that leadership remains focused on sustained profitability.
Another common structure ties incentives to an eventual sale of the company. In this case, executives might receive payouts only if the business is sold at a multiple of the private equity firm’s initial investment. This aligns leadership goals with the investors’ long-term exit strategy.
Why Accurate Valuation Matters
Regardless of the type of equity compensation instrument an organization chooses to employ, it is important to estimate the fair value of the equity grant for multiple reasons:
- Financial Reporting Compliance: Ensures that compensation expenses are correctly recognized under Accounting Standards Codification (ASC) 718.
- Tax Considerations: Provides assistance in avoiding potential tax penalties under Section 409A of the Internal Revenue Code.
- Compensation Committee Oversight: Supports equitable and effective executive compensation decisions by providing clarity on the true value of equity grants.
To meet compliance requirements and uphold governance best practices, companies should conduct thorough valuations of equity compensation instruments. These valuations not only mitigate financial and tax risks but also strengthen the alignment between leadership incentives and long-term business success.
Final Thoughts
The post-acquisition phase is a critical time to refine equity compensation strategies. By carefully structuring and valuing these incentives, companies can drive executive engagement, maintain financial integrity, and position themselves for sustainable growth.
LBMC’s dedicated service team specializes in equity compensation valuations, planning, and compliance. We are here to help organizations navigate these complexities, ensuring their incentive structures align with both regulatory requirements and business goals.
Content provided by Jordan Enix.