Executive compensation in private equity owned companies 

Executive compensation in private equity (PE)-owned companies differs significantly from that in publicly traded and non-PE owned firms. These differences are shaped by the unique objectives, investment horizons, and governance models of PE firms. This article explores the types of compensation programs typically provided in PE-owned companies, compares them with other ownership models, and offers insights into trends and best practices. 

To appreciate the nuances of executive compensation in PE-owned companies, it is essential to first understand the core components that are generally included across various ownership types. These typically

include a mix of the following:

• Base salary: Fixed cash compensation.
• Short-Term Incentives (STI): Performance-based compensation, typically based on performance over a one-year period.
• Long-Term Incentives (LTI): Performance-based compensation, typically based on performance over a multi-year period (often equity or equity-like compensation).
• Benefits and perquisites: Retirement / deferred compensation, health insurance, disability benefits, paid-time-off, and other executive perks.
• Severance and change-in-control provisions: Terms for exit or transaction scenarios. 

With a foundational understanding of these elements, we can delve into how executive compensation programs are specifically designed for PE-owned companies. These programs are crafted with often two key guidelines in mind:

• Strong emphasis on alignment with enterprise value creation: Ensuring that compensation structures require enterprise value growth, typically through appreciation-type long-term incentive units. Beyond those incentive units, PE-owned companies uniquely may also ask executives to use equity rollovers and other forms of direct investment to become a direct equity holder to further align outcomes with investors.
• Focus on cash efficiency: Deferring large payouts until exit to align with the investment horizon of PE firms.

While there are a multitude of ways to design programs to achieve growth objectives and incentive executives, the below plan types are commonly utilized:

• Equity plans: Key executives are granted options or profits interests that pay out upon a liquidity event (e.g., sale or IPO). 
• Equity rollovers: Executives often reinvest a portion of their gains from prior transactions into the new entity.
• Phantom equity or SARs: Used when actual equity cannot be granted for tax, control, or structural reasons.
• Transaction bonuses: Lump-sum awards paid at exit if return thresholds are met.
• Retention bonuses: Designed to retain talent through the investment period.
• Deferred compensation: Portion of income is deferred to a later date with pre-tax earnings potential.

To further illustrate the distinctiveness of PE-owned compensation structures, we can compare them with those in publicly traded and non-PE-owned companies. The following table highlights key differences:

One of the most challenging aspects of designing long-term incentive plans in PE-owned companies is determining grant guidelines. Questions such as eligibility, effective LTI vehicles, and appropriate grant values are critical. 

While there is no one-size-fits-all solution, the following guidelines can serve as a starting point for designing effective programs:

To foster alignment and drive performance, adopting best practices in executive compensation is crucial. Key strategies include:

• Aligning long-term incentives with realistic exit horizons and value creation targets, ensuring that executives are motivated to achieve tangible results.
• Clearly communicating compensation, avoiding misaligned expectations among stakeholders.
• Exploring hybrid models, combining cash retention incentives with long-term equity upside to reward both immediate contributions and future growth.
• Regularly benchmarking against market data, maintaining competitiveness to attract top talent in a dynamic landscape.

Executive compensation in PE-owned firms is designed with a laser focus on value creation and alignment with investor returns. While offering potentially outsized payouts at exit, it also carries unique risks and expectations for executives. Understanding these dynamics is essential for both executives evaluating new opportunities and firms seeking to attract and retain top leadership talent.

As you consider the future of your executive compensation program, it may be time to level up your design to better align with company objectives and meet the needs of your executives. Mercer has consultants ready to work with you.