Mar 25 2007 by Jason

What Should I Consider With Management Carve Out Plans?

Question: We are considering selling our VC-backed company. It may not be the optimum time so valuation is a question. My board has asked me to proposed a management carve out plan as a retention tool. What do I need to consider in formulating this proposal?

While management carve out plans were rarely used before the Internet “bubble,” they’ve evolved over time to have fairly standard terms.  In general, you need to consider the amount, form of consideration, how the proceeds are distributed and implications on escrow terms. 

Amount:  Without knowing more about your particular situation, it’s hard to give you guidance on the particular percentage that is reasonable.  Normally, these plans give the participants between 5 and 10 percent of the aggregate proceeds of the deal.  I’ve also seen higher and lower.  The proceeds are usually decreased by any amounts received by the participants under the liquidation preference structure.  

Form:  Plans should distribute the same form of consideration to the participants as the rest of the stockholder base.  However, they should always have a clause that allows cash to be paid out in case the acquiror prefers this, or if you are in a situation where people would otherwise receive fractional shares.

Distribution:  Proceeds under the plan can be allocated by the board, by the CEO, or a combination of both.  Normally, you see the CEO proposing the distributions and the board reasonably approving his / her plan. 

Escrow Considerations:  One piece of negotation is whether or not the management carveout should be subject to escrow provisions.  It seems fair that it should, but the question is what happens with respect to indemnification obligations that go beyond the escrow.  Should management have to take cash out of their bank accounts to cover these amounts?  It’s definitely a case-by-case situation, but make sure that you address this up front, not at the time of the acquisition.

One other item to consider is whether any payouts under a plan like this will trigger any “golden parachute” (280G) situations.  Ask you lawyers and your accountants to do this analysis early on so that you can deal with any potential problems.  What’s 280G, you ask?  See our earlier post.