Within an LBO transaction, the PE fund will want to incentivize their management team. They want the management team to work hard, grow the business, and to run the company as effectively as possible to maximize the company's value or the PE funds exit proceeds. There are two main types of incentives. The first type are earnouts. Essentially bonus payments paid during the investment holding period dependent on hitting performance targets. I.e. if the company does well, the management do well. These have a number of characteristics. Typically, cash is received throughout the holding period, not just at the end. The upside is limited by the terms of the earnout agreement, and the earnout level is dependent on performance of the company only. This is not necessarily ideal. So the second type of incentive is management rollover or rollover equity. This involves an equity holding in the target company for existing management. As they become shareholders, the management's interests and shareholder interests become aligned. It only has value at exits, which incentivizes management to stick around until the end has significant unlimited upside potential. But there is a risk of delays to exit, depending on financial market conditions.

What are the main characteristics of management rollover? Firstly, management must remain with the company until exit to benefits, and they must contribute their own capital. This means they are taking a risk with their own money and they won't leave the company partway through the LBOs life. Secondly, it aligns the interests of the PE funds with those of the management team.

Thirdly, managers can receive favorable tax treatment by postponing their capital gains on selling their shares. Fourth, the equity for the management team may either rank equally or be subordinated to the PE fund equity holding, meaning PE funds may get paid out before the management teams get their share.

And lastly, the management stake in the deal can increase over time due to incentive compensation plans.

This is where additional management percentage ownership is dependent on MOIC, multiple. on invested capital on exit.

MOIC basically means the multiple of exit cashflow to your Invested cash flow. If we managed to multiply our invested capital more than 1.5 times, management would get an extra 2% ownership. If the MOIC was over 2 times an extra 4% ownership, 3 times an extra 6%. So management become heavily incentivized towards selling the company for a high price on exit achieving the higher multiple, and earning their additional percentage ownership.