MIPs aim to align management’s (“Management”) interests with those of business owners, with the goal of maximising the business’s performance. By providing selected employees with an opportunity to invest alongside business owners, Management is retained, motivated and rewarded. Luxembourg’s legal framework provides valuable tools to establish tailor-made MIPs.
The main challenge in MIP implementation lies in creating a structure that satisfies all parties involved without becoming overly complex. Below is an overview of the key considerations when setting up an MIP in Luxembourg.
Determining the instruments in which Management will invest: equity or phantom shares?
There is a growing appetite for phantom shares, consisting of a cash bonus plan based on the value of the company’s shares.
Management often invests via equity, offering managers the potential for share ownership contingent on performance. The most common equity instruments are stock options or classes of shares, which allow Management to have skin in the game and thus incentivise them to work hard and help increase the value of the group. Luxembourg law also offers the possibility to issue free shares to Management under specific conditions.
Additionally, there is a growing appetite for phantom shares, consisting of a cash bonus plan based on the value of the company’s shares. The key benefit of this is Management’s ability to benefit from the increase in share value without being a shareholder. Phantom shares offer flexibility in their design but also on a day-to-day basis. They are cheaper and simpler to administer (especially around shareholders’ decisions) without diluting institutional investors.
Choice of the vehicle(s) in which Management will invest
The legal form of the Management vehicle is a critical step. Several factors should be taken into account when deciding on the legal form, such as the political rights to be granted to the shareholders, the expected number of participants, the confidentiality of the shareholding but also the tax treatment. The most common legal forms used for Luxembourg MIPs are public limited liability companies («SA»), corporate partnerships limited by shares (“SCA”) and special limited partnerships (“SCSp”). These three types of companies preserve the shareholding’s confidentiality and do not have a maximum number of shareholders. SA and SCA have a legal personality, whereas SCSp do not. From a tax perspective, using a SA or SCA, which are viewed as opaque and fully taxable entities, or an SCSp, which could be looked through for tax purposes, would trigger different consequences for the shareholders. SCA and SCSp are of particular interest as they are perfectly suited to sponsors wishing to retain control over the general partner and hence the management of the entity. SCSp are also very popular due to their high degree of contractual freedom. All governance-related provisions can be set out in the limited partnership agreement, thereby avoiding the need to have an additional shareholders’ agreement (which would typically be put in place for SCA and SA).
When the equity route is retained and under specific conditions, Luxembourg law allows a for a grading of the scope of voting rights (from a mere waiver to a suspension).
Management can invest in the business directly with the business owners or indirectly via a pooling vehicle, depending on the preferred governance structure and the volume of participants involved. Having Management sitting in the same vehicle also facilitates an exit.
When the equity route is retained and under specific conditions, Luxembourg law allows a for a grading of the scope of voting rights (from a mere waiver to a suspension).
Specific tax considerations
The tax treatment of a MIP will depend not only on the nature of the expected return (e.g. capital gain, dividend, employment income…) and the type of vehicle used (opaque vs. transparent), but also on the tax residency of the beneficiaries. As the beneficiaries may be resident in different countries, the tax treatment of the MIP would have to be assessed in each jurisdiction. Commonly, a “capital gain” qualification is the preferred route to achieve an efficient tax treatment in the hands of the beneficiaries. For instance, capital gains realised by Luxembourg resident managers on the disposal of shares in a Luxembourg company would not be subject to tax if the manager holds less than 10% of the company’s share capital and the sale is performed more than 6 months after the acquisition of the shares (in case of a sale of 10% or more of the company’s share capital, capital gains would still benefit from taxation at half of the progressive tax rate).
In any case, there would be no one-size-fits all approach, and a tailor-made analysis of each deal and domestic tax rules will always be needed.
MIPs are a powerful tool for sponsors and business owners to drive performance and foster a culture of success. By carefully designing and implementing these plans, businesses can ensure that they are creating a competitive edge in the market. As the business landscape evolves, so too must the strategies for incentivising management, making it imperative for companies (listed or not) to stay informed and agile in their approach to MIPs. The Luxembourg toolbox is well suited and tested, offering attractive options for MIPs.