A recapitalization can give a private equity portfolio company the financial foundation for its next phase of growth. It can also create a compensation problem when the restructuring materially changes the equity available to management. When pre-recap awards are cancelled or replaced, management may emerge with materially lower incentive value and retentive equity just as the company is asking the team to rebuild enterprise value and deliver the sponsor’s investment thesis.

We call this the post-recap compensation dilemma. Sponsors understandably want to manage dilution following a restructuring, but changes to the post-recap equity structure can materially reduce the number or value of shares available to management. The result can be a meaningful gap between the value of original equity awards and replacement awards, with an even larger gap in potential realizable value at exit.

This gap matters. A management team that has navigated a restructuring is often being asked to execute an ambitious operating plan, restore growth, and ultimately deliver a successful liquidity event. Replacement awards with materially lower value can reduce the motivational power of the program at a time when alignment and retention become especially important.

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