When assessing today's private equity employment market, it is striking that although the overall volume of private equity hiring has not changed much recently, the pool of qualified professionals has actually shrunk. This is because firms have significantly narrowed the specification of the candidates they want. The days when not perfectly qualified candidates can get a job in the industry are over. On the other hand, for ideal candidates, neither compensation nor the number of offers received has changed appreciably despite the market downturn.
There are a number of significant employment trends that are underway in the private equity industry:
1. The use of pre-MBA analysts as a core part of the investment team is a trend that has outlasted the bursting of the Internet bubble and is accelerating as senior investment professionals continue to see ways to leverage their own time.
2. Cash compensation levels have stopped rising and are unlikely to return to their formerly torrid pace of increase anytime soon.
3. Carried interest is being distributed further down the ranks than in the past and the LPs like it.
4. Total employment in the private equity industry will shrink more slowly than many expect due to the particular nature of most private equity funds' limited partnership agreements (the money generally cannot be withdrawn and the management fees from which salaries are paid are payable by the LPs for between five and seven years).
5. There has been a profound shift in attitude from candidates pursuing jobs in the industry to now favour the more established private equity firms above the younger, freshly spun-off operation. This preference has grown from the belief that in coming years, LPs will only allocate money to well-established funds, leaving the newer funds empty handed.
6. Private equity firms are now much more focussed on recruiting and retaining their star players.
Defining and finding the ideal candidate
For LBO funds, the ideal candidate profile has not changed much over the past five years – namely, for positions at the associate level or lower, a top-tier undergraduate degree and MBA (for associates) plus tier-one investment banking experience or lateral LBO experience is ideal. For more senior positions, the same profile is preferred but with an increasing preference for lateral LBO experience the higher the level.
In all cases except pre-MBA analyst, compensation generally consists of a generous base salary plus cash bonus plus carry. The carry level is set such that assuming a two times return on the fund, any individual's carried interest (except for General Partners' which is higher) will yield an amount equal to seven years' worth of his or her current cash compensation. To illustrate: for a $500m LBO fund, if an associate earns an average of $250,000 per year over seven years (less in early years and more in later years) and the fund returns $1bn in total ($500m in original capital plus $500m in gain), the candidate should have a carried interest, that yields him $250,000 multiplied by seven. This equates to $1.75m which, assuming a 20 per cent carried interest for the GP would be equivalent to 20 per cent of $500m which is $100m. If $1.75m is divided into this $100m figure then you reach a percentage of 1.75 per cent of the GP carried interest for an Associate level candidate.
What has changed recently is the supply of prospective candidates. LBO funds and the executive search firms they retain are literally flooded with candidates. In the case of my search firm, Glocap, new candidate flow has been up more than 50 per cent in the past twelve months. The reasons for this are obvious: the investment banks have laid-off thousands of people. Secondly, candidates currently working at smaller, less wellestablished LBO funds are also looking to move to the bigger names, which has added to the oversupply situation. Finally, there is a large supply of unemployed but experienced MBAs from the classes of 2001 and 2002 who are seeking employment at these firms.
Many LBO funds are now asking search companies to find either the top-rated investment bankers from the leveraged lending, financial sponsors, high yield or related groups who have not been laid off, or lateral LBO candidates with solid deal experience from a well-known fund. In many cases, funds have sought candidates with some distressed or restructuring experience because a good number of funds have portfolio companies in need of such help.
In contrast to this modest change in recruitment policy, most venture capital firms have substantially changed their definition of the ideal candidate. Simply put, the bar has been raised. Previously, for all but partner-level positions, candidates with a strong undergraduate education and possibly an MBA plus management consulting experience and with or without some operating experience or lateral private equity experience were sought. Now, on the venture side, funds are seeking candidates with technical undergraduate and graduate degrees (engineering or computer science) and serious hands-on operating experience at wellregarded companies.
VC funds have also increasingly turned to recruiters with a pool of technical candidates rather than to conventional private equity recruiters whose VC candidate pool mostly consisted of management consultants or lateral VC candidates. For example, in 2001, nearly 75 per cent of the candidates that Glocap placed into more than 50 venture funds had a technical degree and some technical operating experience whereas in 1999-2000, only about 40 per cent had technical operating experience. This has been a difficult transition to make for the VCs: this is in part because many of the existing investment professionals at VC funds are heavier on business experience than technical experience, so there can sometimes be communication problems or a culture clash when they interview highly technical candidates. As such, the ideal candidate for most VC funds today is a candidate with both a highly technical and a strong business background.
The myth of oversupply
Many industry observers in the US and Europe believe that the balance of power has shifted entirely to private equity firms and the executive search firms that they retain to help them find investment professionals. While this is most definitely true for candidates with less than ideal backgrounds, for top tier candidates with the right backgrounds and great personalities, the competition is actually even fiercer than before. The reason for this is that before last year, private equity firms rushed to build up their investment teams in order to invest in ever more companies with ever larger funds. As a result (and with the benefit of hindsight) many accepted candidates who were for the most part appropriate but were not ideal. Now, private equity firms are less confident about their future and have and are willing to spend the extra time to scrutinise potential hires much more closely.
Prospective employers are also not in any rush to hire because they perceive the supply situation to be in their favour, whereas before they were grabbing warm bodies. This much more highly diligent hiring process takes more time and firms now reject candidates over even only very small issues. Counter intuitively (given supply conditions) therefore, the average time to fill a position is now longer than before and the average number of candidates screened per candidate hired is up more than 40 per cent according to recent research.
Top candidates are now in even greater demand than before because the margin for error has been reduced as the market has become much less forgiving. At the same time, because of the increased requirements to be considered for an interview, the pool of qualified candidates has actually shrunk considerably thereby heightening demand further.
Retention of the stars
Private equity firms have conventionally attracted and retained partner-track investment professionals in large part on the basis of the perceived value of a carried interest and, for non-partner track professionals (e.g., pre-MBA analysts), on competitive current cash compensation. The latter strategy has not changed significantly despite the tough market conditions of last year, nor have compensation levels for junior professionals changed appreciably (salaries are very sticky downwards). However, with the decline in the perceived value of carry, there has been an increasing preference for higher current cash compensation. For instance, several of the vice-president and higher searches I have recently conducted ended with the candidates bargaining hard for higher current compensation in exchange for less carry when it came to final contract negotiations.
Nonetheless, according to the 2002 Compensation Benchmark Report published by Glocap and Venture Economics, overall current cash compensation stopped rising in 2001. The reasons for this are fairly straightforward: first, funds no longer expect to raise ever-larger funds and therefore the same or smaller amount of management fee is being earned (funds generally pay salaries out of their management fee). Second, the job market in the alternative employment areas that investment professionals could work in instead of private equity, such as investment banking or management consulting, are also weak and compensation levels are under pressure in these groups. Therefore, even though non-partner investment professionals want more cash, they are not getting it for the most part (except for those rare star candidates who attract multiple offers).
Retention strategies have instead begun to focus on some non-financial variables such as the stability of the franchise and the performance of the fund (and therefore the value of the carry). Many industry professionals believe that that less-established funds will be unable to raise new capital in a next round of fund-raising and that only larger, more well-established funds will survive. Not surprisingly, these larger, more established private equity firms are voicing this opinion as part of their pitch to potential candidates and to their current staff of professionals in order to retain them.
nother retention tool being used is distributing more carry to non-General Partner level investment professionals. This trend has in part been the result of pressure from the LPs to push carry down through a private equity firm to make sure everyone is pulling in the same direction. It is now considered a plus in an LP agreement if carry is distributed down as low as the associate ranks (some firms have even given equity-like compensation to pre-MBA analysts usually in the form of leveraged co-investment rights on deals the analysts work on).
Difficult market conditions for private equity firms have not translated into substantially decreased hiring initiatives or compensation structures. Instead, the bar has been raised in terms of the profile of the candidates that are sought and firms are spending more time to ensure that the candidates they do hire match this ideal. Firms are also working harder to keep their key recruits once they have joined. At the same time, a return to the basics of venture investing has resulted in an increased preference for highly technical candidates but only if they also have business experience. On the LBO side, the type of candidate hired hasn't changed much but only the candidates who match these criteria are still being selected.
Adam Zoia is Managing Partner at Glocap Search LLC and is based in New York.