Things that go wrong with management incentive plans in private equity owned portfolios
Updated: Nov 30, 2020
Management teams are key participants in private equity transactions. For the success of an investment, alignment of interest between management teams and the sponsor is key. A well designed management incentive plan goes a long way in securing this alignment. Due to its significance, a lot of time and effort goes into structuring an incentive plan that works for all parties.
Given the effort employed, the problem rarely tends to be in the design of the plan. Where things often go wrong in private equity structures is in the implementation and monitoring of the management incentive plans. Some of the recurring issues, which lead to significant time and cost at exit, tend to be:
Dates and cost of share acquisitions, issuances, buybacks and transfers are not tracked properly despite being required (particularly at exit).
Shareholder details (including joiners and leavers) are not maintained in an up to date manner.
Legal documents such, as share registers, do not always match the share capital tables (often kept in excel and not always updated).
Dividend and/or interest accruals on preference shares or investor loan notes are not accurately tracked leading to errors and time-consuming reconstruction before an exit process.
Relevant portfolio company staff do not always have visibility over the incentive plans or access to relevant documentation leading to confusion and lost management time.
Tax valuations, where required, are not always obtained (particularly for later issuances). This can lead to material diligence findings by bidders and haggling over price and contractual protection.
Necessary tax elections – e.g. a section 83(b) election for US tax or section 431 election for UK tax– are not always filed on time or maintained on file, leading to diligence findings by bidders.
All of the above leads to significant time, cost and unnecessary stress. Establishing standardised systems and processes can go a long way in eliminating these recurring issues.
We at DealsPlus are building a system of record that creates a single source of truth across a private equity manager's portfolio investments. One of its features is the ability to update and track company cap tables and underlying legal documents in a standardised manner.