Management Incentive Plans (MIPs) are compensation and incentive arrangements designed by private equity funds to align the interests of a portfolio company’s management team with those of the fund. The main objective is to maximize the profitability of the funds invested in the portfolio company in a timeframe between three and seven years and, so, an MIP links executives’ remuneration to predefined performance objectives tied to business results (e.g., EBITDA growth, financial performance and the company’s valuation on exit).
Funds do not tend to want to be involved in managing the business and, therefore, management of the portfolio company is assumed by executives from outside the fund. For private equity funds, the management team’s experience and know-how are key aspects that must be regulated with the objective of, on the one hand, ensuring the management team’s permanence and, on the other hand, offering incentives that are aligned with the investor's and the management team’s interests. Therefore, the main objective is to motivate the key executives (generally directors, senior executives and senior managers), so they maximize the business value during the fund’s holding period.
Remuneration schemes for executives and directors under a service agreement for executive duties (whether though an ordinary employment relationship, a senior management relationship or a commercial relationship) generally consist of the following: (i) an agreed remuneration package consisting of fixed remuneration (in cash and, normally, with a portion in kind) and variable remuneration tied to performance targets; and (ii) an equity-based incentive plan.
In certain cases, co-investment structures are established in which the executives acquire a direct or indirect stake in the portfolio company owned by the fund and become shareholders. In these cases, the MIP takes effect from the moment the shares are delivered or acquired, and the executives take an investor position.
Experience shows that a well-implemented MIP is key for improving the portfolio company’s profitability. Also, to achieve a well-designed MIP, many commercial, labor and tax factors must be analyzed and, to do so, specialized advice is required.
In this document, we provide a preliminary analysis of the main purposes of MIPs, the structures most frequently used on the market, their advantages and disadvantages, and the main commercial, labor and employment, and tax aspects to be assessed when designing and implementing MIPs.
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