Chapter 6 of 6 · 12 min

Management rollover and the incentive pool

Managers reinvest part of their proceeds and get a slice of the upside. Who ends up with what.

By the end of this chapter you can

Calculate management's proceeds, rollover and ownership of the new equity
Split exit equity between the incentive pool, the sponsor and management
Work out the rollover needed for a target stake
Explain what the incentive pool costs the sponsor

The intuition

You sell your restaurant to an investor who wants you to keep running it. They pay you, but ask you to put part of that money back in, alongside theirs. You now own a slice of the new business, so you care about it as an owner. On top of that they promise you a bonus pool that grows with what the restaurant eventually sells for.

That is a management rollover plus a management incentive plan (MIP). The sponsor gives up a little of its own return to buy a team that behaves like owners.

The key idea

Rollover buys new equity at the sponsor's price, so it cuts the sponsor's check but not its multiple. The incentive pool comes off the top of exit equity, so the sponsor's MOIC becomes deal MOIC × (1 − pool share).

Why it works

Management's proceeds = their stake × equity value before the deal (enterprise value less the old net debt).
Rollover = the share they reinvest. The rest they take home in cash.
New equity = enterprise value − new debt. The sponsor funds whatever the rollover does not; management owns rollover ÷ new equity.
At exit the incentive pool is taken first, as a share of exit equity. The rest, the ordinary equity, is split by ownership, and management also receives the pool.
Rollover does not change the sponsor's multiple, because both buy at the same price. The pool does: the sponsor earns the deal multiple × (1 − the pool share).
Why sponsors insist on it: money at risk aligns the team, a team that will not roll is a warning sign, and every dollar rolled is a dollar the sponsor does not fund. A well-structured rollover can also defer management's tax.

Enterprise value $1,000M, no old debt; management owns 20% and rolls half; $500M of new debt; exit equity 2.5x; pool 10%

Management proceeds: 20% × 1,000	200 (100 rolled, 100 in cash)
New equity: 1,000 − 500	500
Sponsor check: 500 − 100	400; management owns 20%
Exit equity: 500 × 2.5	1,250
Pool: 10% × 1,250	125, leaving 1,125
Sponsor: 80% × 1,125 = 900; 900 ÷ 400	2.25x (= 2.5 × 0.9)
Management: 20% × 1,125 + 125 = 350; 350 ÷ 100	3.5x

The formulas

Management proceeds = stake × (TEV − old net debt)

What their shares sell for.

Rollover = rollover share × proceeds; cash out = proceeds − rollover

Some reinvested, some taken home.

New equity = TEV − new debt; sponsor check = new equity − rollover

The sponsor funds the rest.

Management ownership = rollover ÷ new equity

Same price per share as the sponsor.

Pool = pool share × exit equity; sponsor proceeds = (1 − mgmt ownership) × (exit equity − pool)

The pool comes off the top.

Rollover for a target stake = target stake × new equity

Run the ownership backwards.

Worked example

Equity value before the deal, management's proceeds, the rollover, then the new equity and who funds it.

Drawing the numbers…

See it move

Same deal. Change how much management rolls, the size of the incentive pool and how well the equity does.

Drawing the numbers…

Try this

Raise the rollover. The sponsor's check shrinks and management's share grows, but the sponsor's MOIC does not move: both bought at the same price.
Raise the incentive pool. The sponsor's MOIC falls and management's rises.
Management's MOIC is always above the deal's, because the pool is paid on top of their shares. Raise the rollover and it falls, since the same pool is spread over more of their money.
Raise the exit. All three multiples of money rise.

Run it backwards

Same deal, reversed: the sponsor wants management to own a set share of the new equity through rollover alone. How much must they roll?

Drawing the numbers…

Rollover buys at the same price as the sponsor, so the stake is simply the rollover's share of the new equity. Multiply the target stake by the new equity for the dollars, then divide by management's proceeds to see what share of their sale that is.

A third to a half of proceeds is common. Much more and good managers push back, and the usual answer is a smaller rollover with a bigger incentive pool.

Traps

Computing management's proceeds on enterprise value.

They own equity. Take enterprise value less the old net debt, then their stake of that.

Thinking rollover lowers the sponsor's multiple.

It lowers the sponsor's check and its share of the exit by the same proportion. The MOIC is unchanged; only the pool changes it.

Splitting exit equity by ownership before taking out the pool.

The pool comes off the top. Split only the ordinary equity that is left.

Assuming management's stake is the same before and after.

They rolled only part of their proceeds into a company with more debt. Their new stake can be smaller or larger than before.

Treating the pool as a fixed bonus.

It is a share of exit equity, so it scales with the outcome, which is the behavior the sponsor is paying for.

Say it in the interview

The interviewer asks

“Why do sponsors want management to roll over equity, and how does a management incentive plan affect returns?”

Say yours out loud first, then compare.

Check yourself

4 fresh questions, with new numbers. Answer each one correctly to finish the chapter. Get one wrong and you will see the full working, then you can try it again with new numbers.

Answers within 1% are marked right. Type the number; $, %, x and M are fine. First tries count toward Learned: the topic is Learned once every chapter is done and 75% of first tries were right.

0 of 4

Drawing your questions…

Remember

Management ownership = rollover ÷ new equity.
Rollover cuts the sponsor's check, not its MOIC.
The pool comes off the top: sponsor MOIC = deal MOIC × (1 − pool).
Rollover for a target stake = stake × new equity.