In the current macroeconomic environment, with growing concerns around recruitment and retention in the age of the ‘the great resignation’, there has arguably never been a more important time as an investor to ensure that talent pools in businesses are critically assessed. The right people must be in the right place and at the right time, taking into account the growth ambitions of the business.
Once the talent pool has been identified, it is essential that they buy-in to the vision for the business and fully align with investors, to both think and act like business owners. The Management Incentive Plan (MIP) is one of the key tools to achieve this.
“In our ‘Beyond the Deal’ survey, 82% of companies who say significant value was destroyed in their latest acquisition lost more than 10% of key employees following the transaction.”
Typically, a MIP provides a pool of equity for key talent. The aim is to align the interests of individuals and the sponsor by providing an incentive for management to work hard to increase the equity value of the business by a future exit. If this is achieved and the sponsor’s growth targets are met, key talent stand to participate in a greater share of the equity that they have played their part to create.
Therefore, in the majority of cases, the MIP shares will have terms and hurdles to align participation in equity returns with the sponsor’s targeted returns and goals.
These types of performance conditions can be very simple in nature so that when the sponsor achieves certain returns, the MIP starts participating in the equity value of the business.
However, given the increasing complexity in which businesses operate, it is common to see bespoke arrangements being put in place to align interests on key value drivers including layering performance conditions to provide incremental benefits when higher valuations are reached.
Traditionally, MIP targets and thresholds have been purely economic, but there are increasing discussions around whether and how environmental, social, and corporate governance (ESG) targets can be incorporated into MIPs particularly in certain sectors.
Previously, an invitation to participate in the MIP was extended only to the very senior levels of management. The thinking was that if these individuals were aligned with shareholders, they would cause the behaviours of their teams to be aligned.
Today it is necessary to consider the MIP at a wider talent level to ensure an equitable sharing of the value created between sponsors and the management team as a whole. In addition, it is typical that the definition of key talent is wider and extends beyond the very top tier of management. On a recent project, a MIP extended to over 100 participants, demonstrating a higher level of inclusivity and a great ESG story.
The MIP is critical to align the interests of key talent with shareholders. If structured effectively, it will ensure that all parties are working towards the same goal. Taking professional advice is essential to ensure the MIP is effective as a key piece of equipment in the value creation toolbox. This includes tax valuations to finalise investment cost, and more generally on ultimate implementation which is a hot topic within buy side due diligence. Appropriate tax structuring advice will also ensure the tax treatment of any value realised by key talent is as expected and there are no surprises.
Therefore, the MIP should be considered as early as possible in the deal process given the capital implications and the number of stakeholders involved.
