Management incentive plan
LBOA slice of a buyout's fully diluted equity reserved for the management team, vesting on time served and on returns achieved.
Also written: MIP, option pool, incentive pool, management incentive pool
A management incentive plan is the equity management has not paid for and has to earn, as distinct from rollover equity, which is money the team already had and reinvested. In the structures a candidate will meet, the pool is a low double digit percentage of the fully diluted equity, negotiated deal by deal rather than set by convention.
It vests on time served and, in sponsor deals, on returns achieved, so management is paid out of it only once the sponsor has cleared its own hurdle. That conditionality is the design. The pool is not a bonus scheme, it is a share of an outcome the sponsor also needs, which is why sizing it is a genuine negotiation: too small and the company cannot recruit a finance director during the hold, too large and it costs the sponsor return it did not need to give away.
In modelling terms the pool dilutes the sponsor's exit proceeds, and a returns analysis that ignores it overstates what the sponsor actually receives. How much it dilutes depends on a convention worth stating out loud: a plain share pool takes its percentage of the whole exit equity value, while an option pool struck at entry value takes its percentage of the gain only. The two can differ substantially on the same deal.
It is also not fully granted at closing. Part is reserved for future hires, and grants can be forfeited when people leave, so realised dilution is often lower than the fully diluted figure in the model.
Worked example
Entry equity of 280, of which management rolls 28, with a pool equal to a tenth of the fully diluted equity reserved.
The sponsor holds 81%, the rollover 9% and the pool 10%. On exit equity of 730 the sponsor receives 591 on 252 invested, so 2.35 times rather than the 2.61 times it would have had owning everything.
That is roughly a quarter turn of MOIC and about 250 basis points of IRR. Note the rollover costs nothing: management put in a tenth of the equity and takes 9% of the exit, the same multiple the sponsor earns.