The structuring and negotiation of management incentive plans (MIPs) is now a common and increasingly important aspect of European infrastructure transactions. What types of MIPs are there and what should sponsors consider? We seek to answer these questions below, as well as offer opinions on how MIPs in infrastructure deals are changing.
Forms of MIP
An infrastructure MIP could include employment-based cash bonuses or a share-based MIP.
- An employment-based cash bonus scheme can be established with bonus criteria linked to underlying business performance.
- This can be a standalone arrangement or can be offered alongside a share-based MIP.
- As this is simply a contractual payment, there is more flexibility (than in a share-based MIP) to prescribe (and vary) the terms of payment.
- Employment taxes will typically be incurred.
- Usually, a share-based MIP can be structured with customary strip, sweet and, if desired, hurdle or growth shares, although flexibility may vary depending on the jurisdictions involved. Once in place, amending or resetting the terms of the MIP is difficult.
- Regular dividends could be planned to grant a form of liquidity (although the receipt of such dividends would result in income tax treatment).
- A form of deemed/synthetic exit can also be incorporated. This would allow the managers to dispose of some or all of their shares and the trigger for this can be a time period, a project milestone, or a ‘deemed return’ based on the sponsor’s internal valuation of the business.
- Depending on the jurisdiction in question, the availability of capital gains tax treatment may be a critical structuring point.
M&A transaction considerations
Some considerations for sponsors at the time of the transaction are below.
On the sell-side:
- How can incentive arrangements, such as transaction bonuses, be helpful to align management with the sponsor to achieve a successful exit.
- To what extent will management be allowed to engage with bidders, especially on new MIP terms, given that seller and management interests can diverge?
On the buy-side:
- At what point in time will the bidder start engaging with management to negotiate incentive arrangements?
- What form of arrangement should be offered? Is a share-based MIP appropriate or, given the asset type and planned holding period, would a new framework for employment-based cash bonuses be more suitable?
- Who are the other bidders and what are they likely to offer?
Looking forward, we think three main themes will emerge:
- ESG – A growing trend over the medium term may be the incorporation of ESG metrics as additional KPIs or hurdles for the grant of cash/share awards or the vesting of equity.
- Regulatory requirements – Government regulators are increasingly focusing on ensuring a better alignment of management incentives with performance. Regulators may prefer alignment with delivery of service rather than shareholder returns, and so resist MIPs or require greater transparency.
- Tax reform – Tax treatment (and specifically CGT treatment, or alignment of CGT rates with income tax rates) may come under increasing political pressure and focus, which may result in tax law reform. The result might be an increase in employment-based incentives with sponsors having to factor in (economically) a tax gross-up to ensure management are (on a post-tax basis) still being sufficiently incentivised.
We have analysed infrastructure deals on which we’ve advised over the last five years to look for common themes across infrastructure MIPs. Look out for these findings, which will be shared with our clients.