Some issues with the growing pressure from Investors for Management Teams to have larger and larger amounts of skin in the game, both in listed and private equity situations

February 28, 2020

The Principles of Remuneration that were published by the Investment Association (the “IA”) in November 2019 include the following words: “Executive directors and senior executives should build up significant holdings in their company’s shares. Executives are encouraged to purchase company shares using their own resources in order to provide evidence of their alignment with shareholders.” The UK Corporate Governance Code states that Remuneration Committees should develop a policy on post-employment shareholding requirements, which would require an executive to retain a proportion of their shareholding for a time period after they have left the employment of the company.

It is interesting to compare these words with the words in the 2008 ABI Guidelines which merely stated that: “Shareholders encourage companies to require executive directors and senior executives to build up meaningful shareholdings in the companies for which they work.”

For some time now we have seen management teams in the Global PE and VC investment management industries being required (by their limited partner investors (“LPs”) to commit to investing their own money into the funds that they are managing. In days gone by (pre 2008) the ability of PE and VC investment professionals to co-invest into the funds that they were managing was seen as an attractive perk of the job. But this was because it was their choice as to whether they did and their choice as to how much they co-invested based on what they could afford. Now, because the LPs are now requiring the investment team to put their own money in to the funds on the same terms (other than in the sense that these co-investments typically are not subject to any performance fee) as the LPs, it is seen no longer as a perk, but a pain!

ILPA (the “Institutional Limited Partners Association”) in its recently published Principles 3 – “Fostering Transparency, Governance and Alignment of Interests for General and Limited Partners” states that: “The GP should have a substantial equity interest in the fund. The GP commitment should be contributed in cash as opposed to contributed through the waiver of management fees.” In fairness this principle has been evident in the PE industry for many years now, probably longer in fact than in the UK listed company arena.

We are not surprised to see this increasing pressure on management teams having to put literally their own money into the companies that they work for or into the funds that they are managing. We are, however, concerned that, in some cases, some investors are expecting, nay demanding that the management team co-invest more than they can sensibly afford. Sadly, it appears that the “box-ticking” approach by some investors in PE Funds has become comparable to the approach adopted by some investors in listed companies. If they cannot tick the box, they have to put a “Red-top” on that investment. The result in the PE, VC and Infrastructure investment management world is that if the management team does not commit to co-investing 1% or 2% of their fund personally (even if they genuinely cannot afford to do this) then that investor will not invest in the fund at all. This benefits nobody and means that it is even harder for a new, small but innovative team to go out and raise a new PE, VC or infrastructure fund.

The same observation can also be applied to some institutional shareholders in listed companies. Not all executive directors have lots of cash tucked away sitting in a bank account somewhere. Many of these executives have children to educate and mortgages to pay off. They should already be massively incentivised to increase the TSR for their company by the LTIPs that they participate in. Is it really reasonable to expect them to put all their eggs into the one basket? Or even worse take out more debt to do so? A more balanced and sensible approach is needed in this area.

For further information contact Nigel Mills.

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