Understand management packages and interest rate instruments
The Management Package is one of the tools available to private equity funds in order to associate managers with the creation of value at the exit of an LBO and thus ensure the alignment of the interests of the managers with those of the financial investors. These instruments allow to capture part of the capital gain generated by the investors according to performance criteria defined at the outset. The usual criteria for triggering the remuneration of the Management Package are the investment multiple and/or the internal rate of return (IRR) achieved by the financial investor at the exit of the LBO.
This is to meet the need for the management to be financially at risk in the operation in order to ensure credibility in the management's business plan and for the acquirer to raise debt.
In addition, the financial structuring of LBO transactions generally includes interest rate instruments such as "ADP rates" (preferred shares paying a fixed rate) and/or CBs (convertible bonds) allocated to managers or financial investors.
Measuring the value
The evaluation of Management Package can be approached by recombinant trees or Monte-Carlo simulations. These two approaches make it possible to simulate the financial performance forecasts of the company over the investment horizon of financial investors and thus their performance. These approaches make it possible to obtain a range of possible outcomes (Monte Carlo simulations) or possible discontinuous outcomes (recombination trees) with the probability of occurrence of each outcome and thus to deduce the triggering (or not) of the retrocession of the super-value to the Management in order to deduce a value of the Management Package.
If interest rate instruments are issued at the same time, an important question will concern the remuneration of these bonds. The tax risk is based on the "market" nature of the rate used for these instruments in view of the transfer pricing regulations applicable in France. The tax risk relates to the over-remuneration of these instruments, which could call into question the deductibility of interest, or to under-remuneration, which could lead to the reclassification of the management package as a salary, insofar as the difference in value could fall on the latter.
The evaluation of the management package and the justification of the interest rate to ensure that it is a market rate are thus closely linked.
How can we help you?
The question of valuation at entry arises when the manager invests in specific tools potentially entitling him to a preferential share of the capital gain, subject to the achievement of certain performance criteria by the financial investor (generally IRR or multiple). In this case, it is necessary to validate that the manager does not benefit from any advantage, the payment of a "market price" of the option tool being one of the conditions necessary to avoid reclassification as salary and wages and to justify the so-called market character of the rate used for the issue of interest rate instruments.
Why Olifin?
Olifin has carried out more than a hundred valuation assignments for management packages and complex financial instruments under IFRS 2. We are able to deliver a detailed report and to support and defend our assumptions in front of the tax authorities.
