USA Law and Practice Contributed by: Vijay Sekhon, Brien Wassner, John Godfrey and Justin Macke, Sidley Austin LLP
either through rollover investments, new grants or a mix of both. In founder-led companies, the equity stake may be higher. The instruments used range from direct common equity to options, restricted stock, and profits interests, depending on the corporate form. 8.2 Management Participation Management participation is typically split between the institutional strip and a dedicated incentive pool (“sweet equity”). The sweet equity is junior to the sponsor’s capital and is structured to deliver upside only after a return of capital plus on occasion a pre - ferred return to the fund, usually in the 8–10% IRR range if applicable. In LLCs, this is often implemented through profits interests (which have favourable capi - tal gains tax treatment) or subordinated units, while corporations may issue options or restricted stock. Incentive equity is commonly subject to vesting and Time-based vesting is the most common vesting con - struct (typically four years with a one-year cliff). Exit- based and performance-based vesting are often lay - ered in, particularly for senior executives or founders. Leaver provisions distinguish between “good leavers” and “bad leavers”. governed by a distribution waterfall. 8.3 Vesting/Leaver Provisions • Good leavers typically retain vested equity and may receive fair market value for unvested shares. • Bad leavers generally forfeit unvested equity and may be subject to repurchase at cost or a dis - count. Buyback rights, repurchase mechanics and valua - tion methods are set out in the equity documents and aligned with employment terms. 8.4 Restrictions on Manager Shareholders Restrictive covenants are standard for management shareholders (both institutional and incentive holders) and typically include: • non-compete (12–24 months post-termination); • non-solicit of employees, customers and suppliers; • non-disparagement and confidentiality obligations; and
• IP and invention assignment clauses. These restrictions are contained in employment agree - ments, equity agreements or both. Covenants gener - ally survive termination and remain enforceable while equity is held. Courts assess enforceability based on reasonableness of scope, geography and duration. California remains an outlier jurisdiction where non- Management shareholders usually have limited gov - ernance rights. Control typically remains with the sponsor. In select cases, founders or large rollover participants may negotiate observer rights or limited consent rights over material, adverse and dispropor - tionate changes to their equity terms. Anti-dilution rights are rare and typically not granted to manage - ment outside limited pre-emptive rights if/when nego - tiated by senior management. Management does not control or influence exit timing. However, rollover equi - ty typically includes tag-along rights, and, in some cases, limited consultation rights. Drag-along rights allow the sponsor to compel a sale. competes are generally unenforceable. 8.5 Minority Protection for Manager Shareholders 9. Portfolio Company Oversight 9.1 Shareholder Control and Information Rights Private equity sponsors in US transactions exert tight governance control through a combination of board dominance, shareholder-level veto rights and exten - sive information access. These rights enable the spon - sor to control strategic direction, manage downside risk and drive towards an efficient exit – core tenets of the private equity investment model. Management retains operational autonomy day to day, but strategic levers are firmly held by the sponsor. Board Appointment Rights The following levels of control are encountered. • Majority control – If the private equity fund owns a controlling stake (which is typical), it will have the right to appoint a majority or all of the board of directors of the portfolio company.
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