For private equity firms, providing ownership stakes and other equity incentives to key management employees at portfolio companies is an important step in aligning the interests of all stakeholders and building a foundation for growth.
There are several types of equity available to PE firms seeking to incentivize management of portfolio companies, and many ways to tailor them to firms’ advantage.
Download our free PE Blueprints guideHere is a brief overview of the most common equity incentives:
Options (C-Corps)
Non-qualified stock options (NSO) and incentive stock options (ISO) are types of stock options most commonly utilized by corporations. When you grant options, you’re giving the recipient the right to buy a set number of shares at a fixed price, also called the strike price. A company’s 409A valuation or fair market value (FMV) determines the strike price of an option.
Options to acquire interests (Partnerships/LLCs)
Options to acquire interests are a similar concept to NSOs but used by partnerships rather than corporations. Like corporate stock options, they give a recipient the option to become an equity-holder in the company when they choose to exercise their option.
Profits interests (Partnerships/LLCs)
Profits interest units (PIUs) are the most common form of LLC incentive equity. With PIUs, holders receive a percentage share of the proceeds upon the sale of the company, based on the increase in the company’s value that occurred during the time they held the interest. Unlike options or other capital interests, there is no need to “buy” the units in order to receive the interest.
Phantom equity (Partnerships/LLCs)
Phantom equity is similar to a cash bonus when a company achieves a major milestone, including a share in annual profits, as well as proceeds from a sale. No actual ownership of membership interests is involved (hence the term “phantom”).
Download our free PE Blueprints guide
Get a more in-depth look at the main equity types, as well as a discussion of repurchase rights, rollover equity, and waterfall modeling (LLC/Partnership distribution priorities).
This publication contains general information only and Carta is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that may affect your business or interests. Before making any decision or taking any action that may affect your business or interests, you should consult a qualified professional advisor. This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein.
