Portfolio Company Equity Compensation Plans
As deal-making gains renewed momentum, equity-based incentive compensation plans provided to a portfolio company’s management are becoming a “hot topic” again. The establishment of any equity compensation plan means accepting a certain level of post-acquisition compensation expense. However, the amount of expense recognized and timing of that recognition are both largely dependent on the structure of the award – and certain accounting treatments are often viewed as less favorable than others. For example, while the accounting for stock-based compensation is often a trailing consideration, given its non-cash nature, certain features of a plan can produce unintended accounting consequences that may be hard to ignore.
Often, these unintended consequences can be mitigated, or even avoided altogether, if there is a proactive accounting assessment of the plan during its formation. A focus on four primary areas – the substance of the award, redemption features, exercisability or vesting conditions and forfeiture provisions – can significantly improve an investor’s chances of achieving favorable accounting while still providing management with appropriate incentives.