Why is tech talent so crucial for value creation?
March 22, 2018
It is well recognised that the management team is one of the biggest value drivers for deals, so having an effective Management Incentive Plan (“MIP”) in place to retain and motivate talent is critical to a successful strategy - no matter whether that’s within a buy-out, carve-out, turnaround or a corporate 3-5 year Value Creation Plan (“VCP”).
Now overlay this with the increasing importance of tech talent.
Attracting and retaining tech talent has always been one of the primary constraints on tech companies (as well as funding) but as ‘traditional’ companies are becoming tech companies themselves this is becoming a more universal conundrum. Let’s not forget the potential impact Brexit could have on the bench strength of the Shoreditch, Reading and Manchester IT crowd too.
As a consequence, tech talent has never been in more demand and can attract comparable entry salaries to investment banks. However, this is not always compatible with internal governance (or possibly cash flows) and equally doesn't guarantee retaining historically more transient project-by-project types to buy into and deliver a longer term VCP. In addition, the tax profile of any MIP is clearly important as this drives how much of any value created is retained by your talent.
Whilst quite an extreme example of a MIP with a clear value creation objective, it was widely publicised that Elon Musk opted to forego 10 years of salary for an ‘all in’ $50bn bet - if Tesla hits 12 market capitalisation and 16 operational key milestones.
At a more earthly level:
- Mid-tier tech companies are having to broaden out and be more imaginative with their midterm incentives as the business grows at a more plateaued rate (battling with the ingrained DNA memory of the founder days with the promise of VC returns)
- Mature traditional companies are grappling with separate structures where the tech solution is often carved out of the core business to drive development and external monetisation.
Either way, the most effective MIPs are premised on a more detailed visualisation of where you want your tech business to get to and work back from there.
We’re seeing companies in both camps above take this approach by clarifying what their vision or value proposition is over the next 3-5 years – which can often involve some binary milestones resulting in sharp increases in value.
Understanding what success looks like (and the associated payout) is the best way to drive the right behaviours as these can be different and bespoke, for example:
- Maximise recurring revenues away from an internal anchor client;
- Improve the quality and utility of the technology;
- Generation of new revenue streams from a core technology.
What could this look like in practice?
- Once management have a clear vision for where they want their business to be in 3-5 years, create a tailored incentive plan that connects these incentives and goals by working towards a future valuation on the same basis.
- When you understand what it is your team are aiming for you can structure the plan in the most appropriate form – is it cash, stock, options, some combination of these?
- Assuming you use equity instruments, a defined exit event could then be put into the relevant shareholders legal documentation.
- Periodic valuations might then connect management’s actions (e.g. increasing recurring revenues, diversification from an internal anchor client) with the value they are creating (higher revenue multiple) and therefore maintain their engagement in the company’s vision.
Reward, Commercial, Tax, Valuation and Legal analysis working in unison is critical for effective design and implementation - noting that the tax consequences of poor design to both the company and management can be significant.
To retain tech talent, we need to understand what drives them. Our 'Workforce of the Future' Report explores what's shaping the future of the workplace and what you as a business can do to remain competitive.
Digital disruption within the workforce plays a significant part in realising deal value. We'll be talking about how you can maximise value across the deal lifecycle at a number of intimate roundtables in 2018.
Contact us to find out how we can help you to identify, create and exceed your value ambitions across your M&A lifecycle and to keep updated on our events and roundtables.