During the first quarter following an acquisition, many companies go through a renewed strategic planning exercise to determine the future course of the organization. 

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, meaning that these individuals will share in the future growth in value of the organization.

 

Types of equity incentives

Equity incentives can come in many different shapes and forms.  One relatively simple example, used by both private and public companies, would be a time-vested option to purchase stock in the organization at a predetermined price (the strike price). This type option rewards both loyalty of the employee (due to the time vesting requirements) and appreciation in equity value (as the option payout depends on the difference between the strike price of the option and the stock price. Stock options lend themselves to organizations that have a liquid market for their stock, like public companies.  What we see in the private equity space is often something that is either based on company performance or on the eventual sale price of the overall organization. For example, one may encounter a management incentive unit that vests only if the organization exceeds certain EBITDA targets in each of the following three years.  Another example, based on sale price, would be a management incentive unit that only pays out if the company is sold within a certain time frame, at a multiple of, say, three times the original investment of the private equity buyer.

No matter what type of equity compensation instrument an organization chooses to employ, it is important to estimate the fair value of the grant so that the compensation expense can be recorded appropriately.