Roll-Ups, Rollovers, Retention: Europe's Playbook On Human Capital Businesses

SMART SUMMARY

• In Europe, the winning move isn't always “more equity.” Country-tuned clarity plus team liquidity (cash/hybrid) that respects tax differences is key. US-style incentive exports can underperform if not adapted.
• Treat incentives as a cross-border product with local settings (metrics, rollover, payout cadence) and communicate beyond the C-suite. Do this and attrition risk and deal drag drop materially.

Acquisitions of human capital businesses operating in multiple European jurisdictions invariably focus the attentions of deal teams and their advisors even more closely on incentivisation and employment matters.

Incentivisation is critical to the success of a human capital investment, given its key role in attracting, retaining and rewarding the team members who will drive the success of the both the deal and the business post-acquisition.

Key issues include:

• How are team members currently incentivised and how can that be replicated or replaced in the new structures in a way that further drives performance but does not leave people feeling like goal posts have been moved?
• What are team members getting out of the deal and can they be required to re-invest (e.g. human capital business with wide equity ownership and large deal windfalls may be at risk of losing key team member if any new incentive arrangement is not attractive)?
• How should compensation be weighted as between cash and equity (especially in business such as professional services, where pre-acquisition partners are often accustomed to, and have structured their personal lives around, receipt of significant annual cash distributions)?
• What is the appropriate weighting of individual vs team vs business-wide performance metric (to ensure that the overall incentive structure creates an appropriate focus on individual/team P&L while also incentivising collaboration between individuals/teams to grow wider equity value)?
• How should communication be handled? Finance, accounting and legal professionals will often have a better understanding of deal processes and investor structures and intentions and may therefore need more detailed (and convincing) explanations of why the deal is good for them. These communications can't be restricted to the C-suite, so an investor will need to be prepared to be provide more information about their intentions to a much wider group of people.

In human capital businesses which are necessarily dependent on a number of separate P&Ls (whether geographical, such as with local partnerships, or vertical, such as with sector teams), we often see more complexity in the incentivisation structure, as a result of it being necessary to reward, at least to an extent, individual/team (rather than whole business) performance. This may, although does not necessarily, include a mix of short and longer term incentives linked to specific parts of the business and regular payouts, even if a business-wide exit has not yet been achieved, often coupled with a requirement for participants to reinvest a portion of the proceeds. This is compared to a more typical incentive structure that relates solely to group equity value with proceeds at exit.

Incentivisation complexity ratchets up further where the acquisition target is a platform/roll-up structure, where individuals often hold earn-out rights or minority equity which will crystallise on acquisition of the platform. Re-incentivising those persons post-deal, ideally coupled with tax-free rollover, is important to ensure they remain invested in, and therefore aligned with, the long-term success of the business. However, all of this complexity should not come at the expense of transparency: It is critical that participants understand how their incentives work and the potential value of them so that they are properly incentivised (opaque structures rarely have the desired effect), while of course being clear that the value of incentives of this nature is never fixed. Occasionally, we see “indicative equity valuations” interpreted by participants as “promises”, leading to disillusionment when the payout is lower than presented, which can cause issues on exit. Naturally, all of these incentive arrangements must, where possible, be carefully structured to maximise net proceeds and therefore the incentives for participants, as a structure which is tax-efficient in one country may well be inefficient in another.

Finally, employment laws vary significantly across Europe, with each country providing for differing employee rights, termination procedures and works councils/collective bargaining. It's crucial to understand these, and their impact on the transaction, to ensure compliance and (especially if any employee consultations are required) a smooth transaction process. Employees can generally be replaced more easily in the US than in Europe, so we often see USbased deal teams under-estimating the time and cost required to implement team upgrades in Europe

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.