Challenges associated with incentives in international businesses

17 abril 2024

The international reach of Liberty Corporate Finance means we have extensive experience in offering advice and support to management teams across the globe.

Some aspects of business remuneration structures and drivers are universal. Wherever your business operates, there is a clear need to attract and retain the best possible talent, and to put in place Management Incentive Plans that help achieve that aim.

As well as rewarding and encouraging exemplary performance, successful MIPs incentivise executives to remain loyal to their employer and to feel appropriately recognised for their efforts.

Similarly, organisations in jurisdictions across the globe face the same questions with regard to the “reach” of a MIP. Should it include more junior employees? And in what form precisely should the benefits be delivered – in shares, bonuses or options?

Extra layers of complexity are added to the picture when we are discussing a global operation with teams in various locations. Are the benefits of a MIP to be delivered universally, or should KPIs be decided and evaluated on a regional basis?

As a genuinely international adviser, Liberty is acutely aware of the impact that regional differences can make on the financial strategy to be followed by a business that wants to operate its MIP smoothly and effectively. 

How culture and tax add complication to international MIPs

There are two particularly challenging factors that need to be taken into account by any business with an international presence.

  • Culture: While it is never desirable to engage in stereotyping, there are certain significant cultural attitudes that may influence the thoughts of employees of a particular company on the concept of equity incentives. In some parts of the world, workers are generally content to accept their salary and bonuses without seeking extra long-term incentives. In other areas – the United States is a strong example of this – people are highly attuned to the concept of reward packages that go beyond simple pay and benefits. This cultural variation means you may have to introduce flexibility and nuance to your reward structures.
  • Tax: It goes without saying that different nations tax their workforces in different ways. That means that a global company has to take into account the various tax regimes that apply to its employees when devising the MIPs it wants to offer them.

Market approaches to MIPs

Taking account of those local cultural and tax factors, there are a few “styles” of MIP that have evolved in different regions. Arguably, the different approaches may also be simply a distillation of the house style used by major players in those markets as the local PE markets have evolved from their early stages to more mature developed markets. 

Some of the different MIP structures we see are set out below, along with their pros and cons:

  • “Thin-cap” approach:
    • Most common in the UK and parts of Northern Europe, but can be utilised elsewhere
    • High amounts of shareholder debt coupled with a minimal amount of ordinary equity
    • Equity ringfenced for management can therefore be acquired at nominal cost
    • The sweet equity grows in a linear fashion above a return hurdle (8-12%)
    • Ratchets can be incorporated which transfer additional value from the PE returns to the sweet equity
    • Nominal cost for participants allows broad MIP plans without unwieldy pricing constraints for managers
    • Tends to deliver the highest return parameters to participants versus other programmes
    • Can be hard to make work in certain tax jurisdictions; Netherlands, for example
  • Envy ratio:
    • Popular in the Scandinavian region and parts of Northern Europe
    • Management subscribe for ordinary shares and preference shares alongside the PE house, but with the management split of instruments set at a ratio to give them enhanced returns versus the PE house
    • The value of management’s overall returns are therefore calculated by reference to the returns generated for the PE house, with management typically receiving a multiple of the PE return, the “Envy Ratio”
    • E.g. if a PE house achieves a return of 2.0x their invested capital (cash-on-cash) and the envy ratio is 3.0x then management achieve 6.0x their invested capital
    • The numbers of shares and exact split of instruments will be backsolved based on the acceptable envy ratio to the PE house to get to the correct starting point
    • These schemes are generally less lucrative to managers due to their direct link to the PE returns
    • They are unwieldy because they often have very high cost requirements; the scheme is fundamentally based on how much an individual invests as they then receive a multiple of this sum.
  • Ratchet based structures:
    • Commonly used by US funds, albeit also by many European funds
    • Managers’ equity holding is based on a transfer of value from the PE house to management above pre-determined hurdles
    • For more domestic US funds, the equity pool for management is likely to be subject to both vesting over time and performance hurdles
    • Nature of the ratchet can be:
      • Excess equity ratchet – transfer applies only to proceeds above the pre-determined hurdles. E.g. transfer X% of proceeds in excess of a PE multiple of capital invested of 2.0x, Y% of proceeds in excess of 2.5x etc
      • Total equity ratchet – catch-up ratchet transfer above hurdles. E.g. once PE return is above 2.0x the transfer is X% of all equity proceeds, and so on
    • These structures can be very rewarding, particularly the total equity variants, but as ever it will be dependent on how generous the PE house is with the management participation
    • They can be very complicated for managers to understand and may not fit well with certain tax jurisdictions
    • If not structured correctly they can also become unwieldy where further capital is provided for M&A, for example

Clearly, the decision over the structure of a MIP at an international company will be driven by a myriad of commercial and other factors; and ultimately it must be aligned to the culture of that organisation, the extent of its global reach and the nature of its strategic goals.