More incentives for managers in private equity transactions

"The study highlights the fundamental role of private equity in the growth and enhancement of management; 40% of operators have placed at least three new managers and 81% have used incentives in at least three out of four operations", says Anna Gervasoni, Director General of AIFI, "the contribution of funds on human capital allows for a growth in skills that is fundamental to consolidating the company and enabling it to face market challenges".For Alessandro Piermanni (DLA Piper): "The incentive of the management team is a key element for the success of buy-out operations, these forms of rewards aimed at aligning objectives between investors and managers, contribute to the creation and development of a professional category that is crucial for the growth and competitiveness of companies. It is very important for the proper functioning of the system that the regulatory framework is clear and that there are no uncertainties at the application level".Christian Montinari (DLA Piper) points out that: "Private Equity plays a key role in the economic growth and technological transformation of the country as well as in the rapid achievement of fundamental objectives in the field of corporate sustainability and, more generally, in ESG terms. Therefore, tax regulations are needed to facilitate the human and financial capital dedicated to these changes. In this context, the role and activities of managers are crucial for the achievement of these ambitious goals'.

The role of managers

The research shows that in buy-out operations, a substantial proportion of operators aim at enhancing, stabilising and incentivising the target companies' internal management teams. In the event that external profiles are involved, they are generally inserted in the financial and management area. The figure of the entrepreneur remains, however, central as more than 80% of the respondents have carried out at least one buy out with the involvement of the entrepreneur who remains in the role of manager.
The research also highlights the decisive role of head-hunters, in fact, in 3 out of 4 cases the selection of external managers is carried out through these specialised companies.

Incentives to managers are widely included by operators

The study shows that forms of incentive are present in the vast majority of transactions as this reward model best achieves the alignment of interests between the investor fund and the management team: 81% of operators declare, in fact, that they have included incentives to managers in at least 3 out of 4 transactions.Considering the lesser financial capacity of managers, forms of incentive are mainly through so-called sweet equity instruments, i.e. financial instruments that allow for returns that are more than proportional to the amount invested.Since these returns tend to be correlated to the creation of value deriving from the performance of professional activities, the issue of the tax treatment of these instruments assumes particular importance, since, as is well known, the tax regime of employment income is significantly more onerous than that of income of a financial nature.From this point of view, the market analysis shows that the regulatory change on 'carried interest' (art. 60 DL 50/2017) has introduced in our system an element of great utility for operators, so much so that for 66% of the surveyed sample, the 'sweet equity' tool has become prevalent compared to that of bonuses traditionally taxed according to labour income rates. In fact, it is included by 40% of the operators in more than 75% of their investments. It is thought-provoking that the research shows that these instruments are beginning to be offered not only to CEOs and front-line managers but also to 'middle management'.The survey also shows that at the moment the market has not yet consistently developed managerial performance indicators other than financial ones (e.g. indicators focusing on ESG issues).The factors of the so-called Cash-on-Cash return (i.e. the multiple realised with respect to what has been invested) and the IRR (i.e. the rate of return on invested capital) remain, in fact, preponderant. In this regard, the market shows a preference for a combination of the two metrics, as the use of only one of them may not fully capture the sense of the result actually obtained from the investment.

It remains confirmed that the instruments for the allocation of such returns are essentially those of the allocation of equity or financial instruments and the so-called exit ratchet, i.e. the payment in cash to the managers of part of the proceeds from disinvestment by the investor.

Stock options

The research shows the decline, to the detriment of the instruments described above and especially following the introduction of the carried interest legislation, of stock options.

I Management by objectives (so-called MBO).

The instrument of management by objectives (so-called MBO), i.e. the assignment of individual objectives to managers whose achievement is rewarded through the payment of bonuses, appears to be particularly widespread and linked to the achievement of specific and individualised objectives, not strictly related to the return on investment: in fact, it is included by 65% of operators in over 75% of investments, involving CEOs and the company's first line in 67% of cases, while in 28% of cases it also involves middle management. Specific objectives include those related to the manager's area of activity or even overall objectives (such as mainly EBITDA and Net Financial Position).

Co-investment and re-investment

The instrument of co-investment/re-investment, which involves re-investment by shareholders/shareholders in companies of the investor group or in the target company for the purpose of aligning interests, represents a further operational modality that is included by 55% of the operators in more than 75% of the investments, mainly involving CEOs and first line managers. These re-investments can amount to up to 10-30% of the deal value.

Good leaver' or 'bad leaver' conditions affect repurchase value

An extremely sensitive point analysed by the study is that of the interruptive events of the relationship with the management and the treatment of these circumstances according to the causes that have determined them. In almost all the cases examined, there are conditions of so-called good/bad leaver where, the "good leaver" mainly includes hypotheses of death/invalidity, resignation for just cause and revocation without just cause, while the "bad leaver" mainly includes revocation for just cause and resignation without just cause.The causes of leavership generally preclude the continuation of the corporate relationship by determining purchase/redemption agreements of the shareholdings and/or instruments issued and affect the economic conditions of the repurchase: in the case of good leavers, the repurchase takes place in 92% of cases at fair market value, therefore, in a non-penalising manner, while in the case of bad leavers, the repurchase takes place in 92% of cases at a value lower than fair market value. Interestingly, 95% of the operators did not face a dispute on the existence of good leaver/bad leaver events.