Ratchet
An equity incentive mechanism where management's percentage ownership increases if investment returns exceed agreed thresholds.
Also known as: Management ratchet, Equity ratchet
One-line definition
A ratchet rewards management for outperformance: the better the return for the PE fund, the larger management's equity slice becomes.
Typical structure
Management starts with 10% of equity. If the PE fund achieves 2.5× MOIC, management ratchets up to 15%; above 3× MOIC, management gets 20%.
Alignment function
Ratchets align PE and management interests perfectly — both benefit most from maximising the exit multiple. TS assesses management's skin in the game as a qualitative factor.
Related terms
MBO (Management Buyout)
A transaction in which the existing management team acquires the company, typically with backing from a private equity sponsor.
IRR (Internal Rate of Return)
The annualised return on an investment, expressed as the discount rate that makes the net present value of all cash flows equal to zero.
MOIC (Multiple on Invested Capital)
The ratio of total proceeds from an investment to the total capital invested, without adjusting for time.
Good Leaver / Bad Leaver
Provisions in a management equity plan determining the price at which a departing manager's shares are bought back, depending on the reason for departure.