Over the past several years, private equity sponsors have increasingly pursued take-private transactions. A combination of factors has driven this trend: substantial amounts of dry powder awaiting deployment by PE firms, ongoing market volatility, perceived undervaluation of some public companies relative to their long-term prospects and the rise of private debt financing as a means to facilitate these deals. More recently, heightened macroeconomic and geopolitical uncertainties—including trade tensions and disruptions to global supply chains—have contributed to a more volatile environment, yet these same pressures may also create opportunities for sponsors to capitalize on market dislocations.

One area in which a take-private transaction introduces complex considerations for the PE sponsor is that of executive compensation. Careful planning is needed across a range of issues, from potential severance liabilities to implementing a new compensation philosophy, to avoid surprises that may disrupt management stability at a key inflection point in the company’s trajectory. Below, we outline some of the key U.S. executive compensation issues relevant to PE sponsors in take-private deals.

Potential “Good Reason” Severance Exposure

Public company executives frequently have employment agreements or change-in-control severance plans entitling them to severance or benefits if they resign for “good reason” following a change in control. Common triggers include material reductions in salary or benefits; a substantial diminishment of the executive’s title, authority, duties or responsibilities; or requirements to relocate beyond a set distance. Severance at public companies is typically generous and pegged to levels higher than private companies.

Changes at a target company that naturally occur as a result of a take-private transaction may provide C-suite executives with the ammunition they need to invoke their “good reason” clause. For example, a CFO losing public company financial reporting and investor relations duties might point to a perception of diminished responsibility as a basis to resign and collect severance. Even when such claims are not ultimately valid, the mere assertion of those claims can be disruptive and potentially expensive to resolve.

PE buyers can mitigate this risk by reviewing and renegotiating “good reason” provisions before closing. Executives may be asked to waive any potential triggers tied solely to the shift from public to private status so that it is clear the transaction itself does not automatically allow an executive to walk away with severance. These discussions will often occur in connection with the negotiation of post-closing equity and other compensation arrangements, subject to the timing and disclosure considerations discussed below.

Section 280G Golden Parachute Tax

U.S. tax law adds another layer of complexity for the PE sponsor in a take-private transaction. Certain senior executives and highly compensated employees face a potential 20% federal excise tax on “excess” parachute payments triggered by a change in control, and the corporation may lose its federal tax deductions for such payments. The excise tax on parachute payments generally is triggered when severance, retention payments, accelerated equity vesting or other change-in-control payments exceed three times the executive’s historical average compensation.

Gross-ups for this tax liability were once common, but institutional shareholder backlash has made such provisions increasingly rare. Instead, executives more typically have “better off” cutback provisions that reduce parachute payments to an amount that does not trigger the excise tax unless the executive is better off receiving full payment and paying the taxes themselves. Although this approach may still forfeit the corporate deduction on any excess amounts, it is quite common and typically less controversial and less punitive to the executive than a full cutback.

Private companies can often circumvent this tax exposure—avoiding the excise tax and lost deduction—through the shareholder approval exception, wherein the executive waives any excess amount and at least 75% of the remaining shareholders approve. However, this exception is not available for public companies, including in a take-private transaction. The parties to the transaction often must model out the potential costs, factor them into the transaction negotiations and consider strategies to mitigate the tax exposure (e.g., accelerating bonuses into a year prior to closing to increase base amounts or recharacterizing a portion of the change-in-control payments as consideration for a noncompete).

Compensation Disclosure Obligations

Because the target company is public at the time the transaction is signed, it must comply with SEC disclosure requirements regarding merger-related compensation for its named executive officers. Under Item 402(t) of Regulation S-K, the merger proxy or tender offer statement must disclose tables and narratives detailing the various elements of the executives’ golden parachutes, including severance amounts, accelerated equity, retention bonuses and other deal-related payments. In addition, a separate “say on parachute” shareholder vote (albeit nonbinding and advisory) on the golden parachute arrangements between the soliciting target company and the named executive officers is required under Section 14A(b) of the Securities Act.

The SEC disclosure rules cover agreements and “understandings,” whether written or unwritten, involving the named executive officers of the target, whether such agreements are with the target company or the acquiring PE sponsor. Further, the merger proxy rules separately require disclosure of any substantial interest held by a director or executive officer in the proposed transaction, which can include new entitlements to compensation in connection with the proposed take-private transaction. As a result, any new arrangements between the PE sponsor and the executive officers of the target may be disclosable and in the public spotlight.

Pre-closing discussions with management can be complicated by additional enhanced disclosure rules that are intended to address potential management conflict-of-interest concerns. Pre-signing discussions about post-closing employment, retention programs or equity arrangements may raise claims of conflicted transaction negotiations, and the public company board and the PE sponsor may each have incentives (though not perfectly aligned) to limit access to management prior to closing. This limited access can complicate—or, from a timing perspective, compress—critical discussions involving management equity, rollover and other important closing matters. Navigating these sensitive issues is often a critical feature of management negotiations in take-private transactions.

Management Equity

Outstanding Public Company Awards. The existing equity plan documents and terms of the merger agreement generally govern how public company equity awards held by management are treated in a take-private transaction. In most cases, in-the-money stock options are cashed out at closing for their spread value, while time-based restricted stock and restricted stock units (RSUs) may either be cashed out or assumed and replaced with an equivalent-value award (equity or cash-based) under the new private structure. Performance awards typically vest at a level specified by the plan or the compensation committee—often target or actual performance (potentially prorated for the truncated performance period)—and are then either cashed out or converted into replacement awards, like the time-based RSUs. These decisions are heavily negotiated, and in practice, cashing out awards for cash consideration at closing is simplest and common in public-to-private deals.

Management Equity Under Private Ownership. After the closing, private equity sponsors usually offer a combination of co-investment and incentive equity (often in the form of options or profits interests) to ensure the leadership team has “skin in the game” for the next chapter. Co-investment, in this context, is generally made by the executive in cash on an after-tax basis—using transaction proceeds or other capital—rather than through a rollover of executives’ public company shares because the availability of a tax-free rollover is limited. With respect to the incentive equity, because public company employees may be used to liquid public markets and annual grants of full-value awards, sponsors should clearly communicate the mechanics of different private equity pay structures:

• Shift to appreciation awards: Executives accustomed to full-value awards (like RSUs) will typically receive stock options or profits interests in the PE portfolio company. These instruments carry potentially high upside but can become worthless if the investment underperforms. Profits interests, though increasingly prevalent, can be more complex than options from a tax and operational perspective, thereby requiring detailed explanation to management.
• Front-loaded grants: Rather than annual equity grants, PE sponsors commonly provide one substantial equity grant at the time of acquisition, intended to cover multiple years within the sponsor’s typical investment horizon.
• Illiquidity and extended time frames: Because PE equity awards rarely have an active market, executives should expect a multi-year holding period until the sponsor exits. These awards also may be subject to call rights if the executive’s employment terminates. While vesting may accelerate upon a future sale of the company, day-to-day trading is not an option.
• Targeted participation: Although some sponsors extend equity opportunities to broader employee populations, it is more common for PE firms to limit direct equity participation to a narrower group of key contributors. Cash-based bonus programs typically fill the gap for the broader workforce.

Taking a public company private with PE backing gives rise to a broad spectrum of executive compensation issues, each of which must be carefully addressed. The time and effort invested in doing so, however, will help align the interests of the sponsor and management, minimize uncertainty and provide a firm foundation for the company’s next chapter.

Private Equity Report Spring 2025, Vol 25, No 1