A management carve-out plan is appropriate when key employees hold primarily common stock that will receive little or no proceeds in the acquisition due to the liquidation preference overhang from preferred investors. Carve-out plans ensure that the people the acquirer most wants to retain are financially motivated to support the transaction and remain post-closing, addressing the misalignment created when common stockholders would otherwise receive nothing.
Management carve-out plans are most common in M&A transactions where the aggregate deal consideration is insufficient to meaningfully compensate management through their existing equity holdings. This occurs frequently in acquihires where the purchase price is modest, in distressed or down-round acquisitions where preferred stock liquidation preferences consume most or all of the merger consideration before common stockholders receive anything, and in transactions where key employees hold stock options that are underwater. The buyer's primary motivation for supporting a carve-out plan is ensuring that the management team it wants to retain has a meaningful economic incentive to close the transaction and remain employed post-closing. Gurpreet Bal notes that in his experience structuring these plans, the carve-out pool typically ranges from 5% to 15% of the total deal consideration, though the range varies significantly based on the transaction dynamics.
A board approving a management carve-out for executives who are also directors or officers must be careful to satisfy its fiduciary duties to all stockholders. The approval should be made by disinterested directors, should be documented as part of the overall negotiation of deal terms, and should be justifiable as in the best interest of the company — typically because it is necessary to retain management for the transaction to succeed.
Management carve-out plans create an inherent conflict because the management team that is negotiating the transaction on behalf of the company is also a beneficiary of the plan. The board must carefully manage this conflict through a process that demonstrates the plan was approved in good faith and in the best interests of the stockholders. In Gurpreet Bal's practice at Foley and Lardner, he advises boards to consider forming a special committee of disinterested directors to evaluate and approve the carve-out plan, obtaining a fairness opinion or independent advisor's assessment of the plan's reasonableness, ensuring that the plan does not reduce the total consideration available to stockholders below what they would receive without a deal, and documenting the business justification for the plan, including the risk that key employees would depart without it and the resulting impact on deal certainty and post-closing value.
Carve-out plans are typically structured as a defined pool — often 5-10% of net transaction proceeds — allocated to specified employees based on a formula approved by the board or compensation committee. The pool may be structured as bonus payments, accelerated equity vesting, or a synthetic equity pool. Participants must usually remain employed through the closing to receive their allocation, providing retention incentive through the transaction period.
Carve-out plans can be funded from several sources. The most common approach allocates a portion of the merger consideration that would otherwise be distributed to stockholders, effectively redirecting value from equity holders to management. Alternative structures include buyer-funded retention payments that sit outside the merger consideration entirely, which avoids the stockholder-to-management value transfer issue but increases the buyer's total deal cost. The allocation among management participants typically follows a board-approved framework that considers seniority, criticality to post-closing integration, existing equity holdings, and the individual's role in the transaction process. Gurpreet S. Bal advises boards to document the allocation methodology and the rationale for each participant's share to create a defensible record in the event of a stockholder challenge.
Management carve-out payments are typically structured as compensation rather than capital gains, meaning they are subject to ordinary income tax and employment taxes rather than the lower long-term capital gains rate. If the carve-out is structured as accelerated equity vesting or synthetic equity tied to stock value, Section 409A compliance issues may arise. Companies should obtain tax advice before finalizing carve-out plan design to ensure the intended tax treatment is achievable.
Carve-out plan payments are generally taxable as ordinary compensation income to the recipients, subject to employment tax withholding. If the plan provides for deferred payments, such as installments tied to post-closing retention milestones, the plan must comply with Section 409A's deferred compensation rules or qualify for the short-term deferral exemption. Payments made in connection with a change of control may also implicate Section 280G golden parachute rules, which impose a 20% excise tax on excess parachute payments to disqualified individuals and deny the payor a tax deduction for such payments. Gurpreet Bal advises companies to model the Section 280G exposure for each carve-out participant before finalizing the plan to avoid unexpected excise tax consequences that undermine the plan's retention objectives.
Gurpreet's advice: the best time to get started on a carve-out plan is now — before a transaction is on the table. Plans adopted under deal pressure invite scrutiny. Plans adopted in the ordinary course, with proper board process and no buyer in sight, are far easier to defend.
Gurpreet S. Bal is a Partner at Foley and Lardner LLP in Silicon Valley, where he advises startups, founders, and investors on mergers and acquisitions, venture financings, IPOs, and cross-border transactions. He has advised on more than 50 M&A transactions with aggregate deal value exceeding $60 billion across AI, semiconductors, fintech, and emerging technology.