Key Considerations for Private Equity Sponsored Long Term

Investors entrust their funds to Private Equity (PE)

firms with the primary aim of increasing the value of

their investment. As Fund Managers, PE firms are

saddled with the responsibility of investing in profitable

portfolio companies, ensuring safety of investors’ funds

and surpassing expected rates of return. To achieve

their objectives, PE firms typically leverage Long Term

Incentive Plans (LTIPs) that provide management and

other key employees the opportunity to share in the

success and value that they help to create. This serves

to inspire commitment and performance.

LTIPs are pay plans used to reward performance over

a period longer than one (1) financial year, usually

three (3) to five (5) years. There is an increasing trend

of PE-sponsored LTIPs in portfolio companies, as PE

firms continue to emphasise the need for alignment

of interest of key employees to investors’ objectives.

For most LTIPs, eligibility is usually restricted to Senior

and Executive Management employees, and, in some

cases, high performing / critical roles on lower levels.

LTIP benefits are tied to achievement of predetermined

Key Performance Indicators (KPIs), usually linked to

the investors’ objectives. Examples are increase in

Equity Value / Share Price of the portfolio company and

profitability measures such as Earnings Before Interest

Tax, Depreciation & Amortisation (EBITDA), Profit Before

Tax, Return on Equity, et cetera.

There are various types of LTIPs available to PE firms for

motivating and retaining management and other talent

that will help achieve their growth agenda. The type

and structure of the LTIP adopted is a function of many

parameters, which we have examined below:

 Equity Vs Cash-Settled LTIPs: PE firms can choose

one or a combination of the following:

Equity-Settled LTIPs: This type of LTIPs allow

eligible employees to become shareholders, by

granting them company shares at no cost or at

a predetermined price. Equity-settled schemes

are easier to implement, where there is a ready

market for the underlying shares such as in

publicly-quoted companies. The quantum of

equity awarded will vary based on the available

share pool, employee’s role and achievement

of predetermined corporate and individual KPIs.

Examples of such schemes include Share Awards

and Share Option Schemes.

Cash-Settled LTIPs: In some cases, payout/

proceeds from LTIPs are settled in cash. This

option is desirable when there are no shares

available or to mitigate share dilution. Other

times, a cash-settled LTIP is adopted when

regulatory requirements for equity-settled

benefits are cumbersome or expensive to

comply with. It is important to note that the

value of cash payout is usually tied to the

underlying shares/equity to ensure alignment of

interest. Examples are Deferred Bonus Plans,

Profit Sharing Plans, Performance Share Units

/ Phantom Share Plans, et cetera. In private

companies, phantom units and other cash-settled

schemes are easier to implement, where shares

are not tradable in an active market.

 Strategic Objectives of the PE Sponsors/

Investors: Generally, LTIP payouts are tied to vesting

conditions, such as tenure and predetermined KPIs.

For PE-sponsored LTIPs, there is an alignment

between the KPIs and the investor’s objectives.

Therefore, the quantum of payout that will crystallize

depends on how well the investors’ objectives have

been achieved. This may result in a payout that is

below and above a target amount, but also, usually

subject to a cap to prevent unintended windfall and

excessive risk taking.

 Lifespan / Period of Investment: The investment

lifespan plays a critical role in determining the vesting

period, vesting schedule and grant cycle of a PE-

sponsored LTIP. Vesting or exercise is usually aligned

with the investment period or a liquidity event. This

ensures alignment of interest and helps the PE

firm determine whether it has achieved its overall

objective for that portfolio company.

Investors may implement varied vesting schedules,

such that a larger quantum of payout vests at the end

of the vesting period, compared to equal percentages

annually. Accelerated vesting may occur in the

case of an early exit i.e. before the end of the target

investment period. Also, one-off grants are common

where the Investor anticipates eventual exit from

the company compared to multiple grants for longer

investment periods.

 Instituting the LTIP: A PE-sponsored LTIP may

be instituted in the PE firm or in the portfolio

Key Considerations for

Private Equity Sponsored

Long Term Incentive Plans

By Boluwaji Apanpa and Busola Farinmade of KPMG Nigeria

company (in this case, the portfolio company will be

responsible for the LTIP, while the PE firm funds the

LTIP benefits and cost). The decision on where the

LTIP will be instituted is driven by regulatory, tax and

accounting considerations, as discussed below.

 The Memorandum and Article of Association

(MEMART): In Nigeria, the MEMART must contain

a provision that empowers the company to engage

in share-based payments. A company contemplating

such arrangements must, therefore, check that such

provision is in place or put one in place. A resolution

is required to amend the MEMART and must then be

filed with the Corporate Affairs Commission.

 Sustainability: Although PE Investors may exit a

portfolio company, if the new investor perceives

sustainability, this can enhance the sale / exit value.

PE firms, therefore, also seek to use LTIPs to drive

a sustainability mentality in management. To do

this, a portion of the LTIP proceeds due at exit may

be deferred for a period of one (1) to two (2) years.

The deferral can promote retention as well as aid

implementation of clawback provisions, in case

of misconduct or misstatement in the underlying

financials. Also, a mandatory holding requirement,

which requires employees to hold shares or

units for a period of time before disposal, may be

incorporated. Another way of ensuring sustainability

is to include non-financial KPIs as part of the

vesting conditions. Where the scheme sits at the

portfolio company, it is easier for the new investor

to administer the deferred component or enforce

clawback.

 Tax Implication and Efficiency: LTIPs have tax

implications for the company and employees. It

is important to review the tax implications in

deciding on the type and structure of LTIP to adopt.

Participating employees need to understand the

tax implications of the scheme and the role they

have to play. For example, in Nigeria, LTIP payout

qualifies for personal income tax, while dividends are

considered franked investment income and subject

to 10% Withholding Tax. Also, tax is not triggered

until employees receive LTIP benefits. Therefore,

employees can be allowed to sell a portion of their

vested shares / units to offset tax liabilities, at the

time of tax-trigger. From the company’s perspective,

LTIP payout and the scheme running cost qualify

for corporate tax deductibility under the caption of

staff cost. However, this depends on whether the

LTIP is instituted in the PE firm or with the portfolio

company. If instituted at the PE firm, which does not

have a taxable presence in Nigeria, the corporate tax

benefit will be lost.

 Accounting Considerations: The International

Financial Reporting Standard (IFRS) 2 (Share-Based

Payments) provides guidelines for recognizing and

accounting for LTIPs that are linked to company

shares. An increase in expenses (in the income

statement) and a corresponding increase in liability

or equity is recognised for employee share-based

payments in a company’s annual report. The

Standard stipulates that fair value of the equity

instrument should be recognised at the time of grant.

The company’s share price is often a key component

of this valuation. For publicly quoted companies, the

market price is readily available, while for private

companies, a valuation is required to determine the

share price. The valuation of the equity instrument is

dependent on how it is structured. The professional

valuing the arrangement must have a thorough

understanding of the scheme structure and all the

key parameters.

In line with global practices, disclosure of LTIPs are

required. Therefore, auditors also need to ascertain

that the transaction has been properly valued and

accounted for.

 Impact on Social Security Contributions: It is

important to check whether payout via cash or shares

may form the basis of computing social security

contributions such as pension, health insurance for

the employer and employee. If this is the case, this

may imply an increase in social security liability for

both the company and/or employees. In Nigeria,

payouts from LTIPs are not included in computing

employer and employee contribution towards

pension. In countries like South Africa, gains from

LTIPs form part of employee remuneration for the

purpose of computing employer and employee

contribution to social security schemes like the

Unemployment Insurance Fund, a scheme that gives

short-term relief to workers when they become

unemployed or are unable to work because of

maternity, adoption leave, or illness, and the Skills

Development Levy, imposed to encourage learning

and development and determined by an employer’s

salary bill.

 Other Regulatory Considerations- Other regulatory

provisions may impact the LTIP and should be

carefully assessed to mitigate any penalties that

may arise from regulatory infractions. Globally, there

are various regulations guiding implementation of

LTIPs, including use of shares for compensation and

related costs such as stamp duties. Various Codes of

Corporate Governance provide guidance on Executive

Compensation practices, as shown below:

The United Kingdom Corporate Governance

Code encourages the implementation of

share-based remuneration, including holding

requirements for Executives. In addition, full

disclosure and shareholder’s “say-on-pay” are

required.

In Nigeria, the following apply, amongst others:

• Central Bank of Nigeria’s (CBN) Code of

Corporate Governance encourages the use of

LTIPs for Executive Compensation.

• The draft Financial Reporting Council of

Nigeria’s Code of Corporate Governance also

encourages LTIPs for Executives.

• The Companies and Allied Matters Act

requires a company to disclose any

substantial ownership of its shares by any

shareholder (at least 10% of unrestricted

voting rights).

• In addition, the Investments and Securities

Act empowers the Securities and Exchange

Commission to regulate investments and

securities business in Nigeria, including share

ownership and options.

The following are critical for implementing a LTIP:

 Board Approval and/or Board Resolution: Where

the LTIP is instituted in the portfolio company,

the company’s Board of Directors would give the

mandate and approve the scheme structure and

implementation framework. The remuneration

committee is typically responsible for making

recommendations to the Board on LTIPs and other

matters.

 LTIP Implementation Documentations: This is

a very critical aspect of the LTIP implementation.

There should be a scheme rules / policy document

that clearly articulates the following, amongst others:

Objectives of the LTIP

Eligibility - to specify employees that can

participate in the LTIP

Performance / vesting conditions – to articulate

the requirements for vesting of LTIP benefits

Share pool / grant size – to define the size of the

benefits to be awarded

Treatment of exits and new joiners to the LTIP

Clawback provisions – to create a mechanism

for recouping excess LTIP payout due to a

misstatement in the underlying financials.

Tax implications

The LTIP Rules / Policy is necessary to provide clarity

on the LTIP’s objective and engender employees’

trust and buy-in. The LTIP Rules / Policy should be

communicated and made available to the eligible

employees. Depending on the type of LTIP, the other

scheme documents to put in place are Offer/Grant

Letter, Vesting Letter, Exercise Letter, and Trust Deed.

 Scheme Administration: LTIPs may be managed by

the Human Resources (HR) team, where the required

skills and competencies exist internally. Some of the

areas where HR can assist include:

Issuance of grant letters and scheme rules to the

eligible employees

Collation of individual acceptance letters

Periodic tracking of any new joiners and exits

from the LTIP

Documentation of promotions and any role

changes that may impact LTIP grant

Tracking performance scores/ratings and its

impact on LTIP awards

Pay review decisions that may impact LTIP

Review of payout computations

Notification to employees of payout

Review of tax computations on LTIP payout.

An organisation may outsource the above functions

to an independent rewards consultant or a Trust

Fund Manager. For equity-based schemes, the

company may require a Trust to administer the

LTIP, while for cash-settled schemes, the company

can choose to leverage internal resources for the

LTIP administration with the relevant support from

a rewards consultant. A Trust Deed is required to

spell out the role of the Trustee and the company in

managing the LTIP.

Human Resource Professionals are critical change

agents in implementing PE-sponsored LTIPs. As strategic

partners, HR professionals need to have a holistic

view of the LTIP and partake in the conceptualization,

design and administration of the LTIP, especially, where

instituted at the portfolio company. Also, all employee-

related information and HR policies should be organized

and collated in an information system that is easily

accessible. Aside LTIP implementation, the goal is to

ensure that HR professionals are positioned to supply

information for due diligence activities and perform

critical change management roles that come with,

Mergers & Acquisitions and entry of new PE Investors.

The success of any PE-sponsored LTIP is hinged on

its ability to align employees’ interest with Investors’

objectives. Therefore, the LTIP structure, performance

levels / parameters must be aligned to the Investors’

objectives and should be predetermined and

communicated. However, it is very critical that an

independent rewards consultant is engaged from the

onset to ensure that the desired objectives are achieved

and unintended consequences avoided.

kpmg.com/socialmedia

KPMG network of independent member rms afiated with KPMG International Cooperative