GERMANY Law and Practice Contributed by: Georg Linde and Kamyar Abrar, Willkie Farr & Gallagher LLP
law, they must be structured to comply with takeover regulations, especially those regarding equal treat - ment and transparency. 8. Management Incentives 8.1 Equity Incentivisation and Ownership Equity incentivisation of the management team is a well-established feature of private equity transactions in Germany. Sponsors routinely implement manage - ment equity participation programmes (MEPs) to align key executives’ interests with those of the investor and to drive long-term value creation throughout the investment horizon. Management equity typically ranges from 3% to 20% of the fully diluted share capital, depending on factors such as company size, management’s track record and negotiating leverage, and the extent of reinvest - ment by founders or sellers. Equity is often structured through a mix of direct shareholdings, “sweet equity”, and virtual or phantom instruments. These arrange - ments are generally subject to vesting provisions, good leaver/bad leaver mechanics, and liquidity tied to exit events. German tax, employment, regulatory and corporate law considerations significantly influ - ence the structuring of such programmes. 8.2 Management Participation Although virtual participation models and option plans are available in the German market, the most com - mon and tax-efficient structure continues to be indi - rect share ownership through a management pooling vehicle, usually organised as a limited partnership ( Kommanditgesellschaft – KG ). The management acquires limited partner interests, whereas the gen - eral partner and any warehousing entity are controlled by the sponsor, allowing the private equity fund to centralise governance. Incentive structures commonly involve either pure “sweet equity” – granted on more favourable terms to management to deliver enhanced upside – or a com - bination of “sweet equity” and the “institutional strip”, representing the investor’s senior capital contribution, often with preferred return rights and downside pro - tection.
Managers generally hold subordinated equity (ordinary shares, growth shares, or separate profit-participating classes) that participate only in value above certain thresholds. In contrast, the sponsor typically invests (additionally) through preferred shares or shareholder loans, ranking senior in the capital waterfall. Careful tax planning is essential to ensure returns are taxed as capital gains rather than employment income, particu - larly given the evolving scrutiny from tax authorities. 8.3 Vesting/Leaver Provisions Vesting provisions are standard in German pri - vate equity-backed management equity schemes, designed to promote long-term alignment and reten - tion. Time-based vesting over a three-to-five-year period is most common, frequently including an initial cliff followed by linear vesting. Alternatively, vesting may be performance-based or tied to exit events. Leaver provisions distinguish between: • good leavers: typically departing due to death, disability, retirement, or termination without cause. Good leavers may retain vested equity and are often entitled to fair market value for unvested por - tions; • bad leavers: those terminated for cause or who resign voluntarily without good reason. Bad leav - ers generally forfeit unvested shares and may be forced to transfer vested shares at a discount or nominal value. Until early 2025, German case law created by the Federal Labour Court ( Bundesarbeitsgericht ) permit - ted bad leaver provisions in virtual option schemes. However, in a pivotal decision issued in March 2025, the court held that contractual clauses mandating for - feiture of virtual options upon voluntary resignation are invalid for being unreasonably discriminatory under employment law. This ruling calls for more nuanced drafting of virtual schemes to withstand judicial scru - tiny. Leaver regimes are typically embedded in the share - holders’ agreement and must be carefully structured to remain enforceable under German employment and contract law.
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