Insight
November 13, 2024

Trends in Equity Repurchasing in PE: Rollover vs. Incentive Equity

Our analysis of recent repurchases enabled us to identify trends in the varying treatment of “good leaver,” “bad leaver,” and “no fault” scenarios.

Private equity (PE) sponsors often provide incentives to founders, equity holders, employees, directors, and officers of portfolio companies in the form of rollover equity or incentive equity to align their interests with those of the sponsors. Sponsors usually negotiate for a right to repurchase these equity stakes when an equity holder departs, but the terms are often different for rollover equity and incentive equity, and the conditions under which the equity holder departs can significantly affect the terms of the repurchase.

To shed light on current dynamics in the space, we conducted a poll of M&A partners in Goodwin’s Private Equity practice to understand how sponsors are handling repurchases of rollover equity and incentive equity in “good leaver,” “bad leaver,” and “no fault” scenarios.

In summary, we found that:

  • Sponsors generally offer better terms for rollover equity, including in bad-leaver situations in which equity holders often get the amount of their investment back. This highlights one of the ways in which sponsors can offer incentives to management to roll over, helping to ensure incentives are aligned.
  • Incentive equity is usually forfeited in bad-leaver situations.
  • In no-fault situations, such as death or disability, most sponsors repurchase at fair market value.

The analysis below provides sponsors with insights for structuring management equity and repurchase provisions. We hope it will help inform their efforts to design effective compensation packages, establish appropriate repurchase terms, and prepare for management transitions — and thus balance imperatives to protect investments and treat departing equity holders fairly.

Why and How PE Sponsors Use Equity Repurchase Rights

PE sponsors maintain the right to repurchase management equity primarily to control their capitalization table when management changes occur. These repurchase rights serve two main purposes: equity management and risk mitigation.

For equity management, sponsors need the ability to reclaim equity from departing employees so they can either redistribute it to new hires or retire it, thereby increasing the ownership percentage of remaining stakeholders. This flexibility is crucial for maintaining appropriate incentive structures as management teams evolve.

From a risk management perspective, repurchase rights protect the company by restricting access to sensitive information, preventing its potential flow to competitors through former employees, and by blocking unintended third-party ownership that could result from events such as divorce or bankruptcy proceedings.

The specific terms of these repurchase rights vary depending on the type of equity involved. Rollover equity, which represents management’s reinvestment of their pre-acquisition ownership stakes, demonstrates significant financial commitment and confidence in the future growth of the business. Incentive equity, typically offered as stock options, profits interests, or phantom equity, is granted as compensation to align management’s interests with future growth and usually includes vesting conditions.

Both rollover and incentive equity align incentives to ensure management has appropriate “skin in the game,” but their fundamentally different nature and terms result in different treatment when it comes to repurchase rights.

Repurchase Rights: Triggers and Pricing

PE firms typically structure repurchase rights around three categories of triggering events — good leaver, bad leaver, and no fault — and each usually has distinct pricing approaches.


Good-leaver events

So-called good leavers depart under amicable circumstances, such as termination without cause or certain resignations (which may be limited to resignations for good reason). Survey data shows strong consensus for pricing at fair market value (FMV) in these good-leaver situations:

  • Rollover equity: 82% use FMV; 16% are exempt from repurchase.1
  • Vested2 incentive equity: 100% use FMV.

Bad-leaver events
Equity holders are considered bad leavers when they are terminated for cause or breach a restrictive covenant (such as a noncompetition, nonsolicitation, or confidentiality covenant). “Cause” is usually defined in employment agreements or organizational documents, often with provisions allowing a retroactive cause determination if evidence emerges post-departure. In these situations, sponsors typically take a punitive approach to pricing:

  • Rollover equity: 75% price at lower of cost or FMV; 16% forfeit at $0.
  • Vested incentive equity: Two-thirds forfeit at $0; one-third price at lower of cost or FMV.

No-fault events
No-fault events include death, disability,3 bankruptcy, or divorce-related transfers. Pricing is generally more accommodating in no-fault situations:

  • Rollover equity: 70% use FMV; 12% use lower of cost or FMV; 12% are exempt from repurchase.
  • Vested incentive equity: 83% use FMV; 10% use lower of cost or FMV.

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Our analysis substantiates that sponsors take a nuanced approach to repurchase rights to balance competing interests. While PE sponsors need to maintain control over capitalization tables and manage risk, they also recognize different types of equity warrant different treatment. This recognition goes beyond simple fairness — it reflects sophisticated deal structuring that supports broader investment objectives (including offering incentives for rollovers). The data highlighted above offers important guidance for structuring future deals and suggests that, while protecting sponsor interests remains paramount, the most effective approach combines strong protective measures with thoughtful differentiation based on both equity type and departure circumstances.

 


[1] “Exempt from repurchase” and “not repurchasable” usually means that the equity holder is entitled to retain equity in the company until a liquidity event (such as a sale, merger, or IPO) occurs.
[2] Unvested incentive equity is typically forfeited upon any termination. 
[3] PE sponsors should pay close attention to how they define “disability,” given the term can be interpreted in many ways. A common approach is to define “disability” as the inability to provide services for 90 to 180 days in any 12-month period.

 

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee similar outcomes.