We are putting together the transaction structure, and we want to ensure our executive team is incentivized to stay through a recapitalization. How do we structure a transaction bonus pool that pays out on performance without triggering massive ordinary income tax for them?

Question

Tyler Smith · Accepted Answer

To secure a successful deal, you must keep your leadership team aligned and committed through the transition, but paying them a standard transaction bonus can trigger an expensive tax bill. Standard cash bonuses are taxed as ordinary income, which can wipe out up to fifty percent of their payout.

To optimize this, you can structure a transaction incentive pool using profits interests or a liquidation carve-out plan rather than standard cash bonuses. If structured correctly prior to the sale, profits interests allow your key managers to participate in the growth of the business and receive capital gains tax treatment on their payout, which is a much lower tax rate.

To implement this, you must establish the plan well before the transaction process begins. Use your long-term V/TO planning to set the performance thresholds. Your leadership team must understand exactly how their Rocks and execution contribute to the transaction milestones.

By converting ordinary income bonuses into capital gains assets, you increase the net wealth of your key executives without increasing the cash cost to the business. This aligns their incentives with yours and ensures they stay focused on driving the valuation up to the finish line.