Building and stealing(5)

The private equity industry is currently going though a severe supply/demand imbalance with regard to people. The amount of money raised in the past year, especially by the largest firms, has outpaced the ability of these firms to apply human resources to all the fresh capital.

Notes Peter Gonye, co-head of private equity and investment banking for executive search firm Spencer Stuart: “The velocity of deal flow is at an all-time high which is placing undue pressure on the capacity of these firms to evaluate and, ultimately, execute transactions.”

According to executive recruiters who service the private equity industry, the need to add qualified professionals in private equity firms has led to a scramble for talent, especially at the junior level. It is a seller's market, to be sure. Cash compensation levels for professionals of every level – from the associates to the senior partners – have ballooned.

Here's the paradox – it's harder than ever to recruit into private equity groups, because these groups are poaching from one another. And if you're at a good private equity group, they'll incentivise you to stay

Jonathan Goldstein

Among the ranks of junior professionals, the most highly prized hires are people who have worked at other private equity firms. And no wonder – these individuals have experience across the many functions of a private equity firm, and are seen as plugging into a large private equity operation more effectively than a junior recruit from a consulting firm or investment bank.

“Because funds are larger and have more dollars they need to invest, they have a greater need for personnel, ” says Jonathan Goldstein, a partner in the New York office of executive search firm Sextant Partners. “But here's the paradox – it's harder than ever to recruit into private equity groups, because these groups are poaching from one another. And if you're at a good private equity group, they'll incentivise you to stay.”

Further shrinking the pool of available talent is the increased sector specialisation of firms and resultant desire among general partners to recruit not simply a vice president but, for example, a vice president with a health care services background.

Groups that track private equity compensation report a surge in pay levels over the past year. According to a recent report from Glocap Search and Thomson Financial, the positions that saw the biggest increases in pay were vice presidents, senior associates and associates, with pay gains of 17 percent, 12 percent and 12 percent, respectively.

Candidates with freshly minted MBAs are being offered $300,000 (€232,000) or more in base pay (see accompanying chart). And this is before bonuses and carry participation, if the later is offered to these junior professionals. Sextant's Goldstein notes that some private equity firms have, in an effort to keep junior talent from having the urge to defect, taken to paying what amounts to extra bonuses to key employees.

I've spoken to a number of firms who said they made a tremendous offer, but lost the person to Carlyle

Sometimes called “spiffs”, these lucrative pats on the back are often drawn from the pool of unallocated carry. Spiffs are sometimes awarded to people who have worked on a particularly strong exit, says Goldstein.

Indeed, most junior private equity professionals are so happy that dislocating them from their current place of employment is sometimes proving to be beyond the budget of an expanding private equity firm. “Going from one shop at X to another shop at 1.2 times X isn't necessarily attractive” for many professionals, notes Goldstein, who adds that firms that decide against raising their compensation budgets may have to “go hunting in a different pool” of candidates.

The largest private equity firms have been adding human resources at a rapid clip. One headhunter says that The Carlyle Group, in particular, has emerged as a particularly aggressive buyer of junior and midlevel talent. “I've spoken to a number of firms who said they made a tremendous offer, but lost the person to Carlyle,” the headhunter says.

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The cash compensation of senior general partners has expanded as well, but for these professionals the far more meaningful compensation component is carried interest. The pool of carried interest remains a carefully guarded treasure, with founding partners and senior partners continuing to receive the lion's share of investment profits.

Spencer Stuart's Gonye says that within the senior-most ranks of partners, there is not the same level of hiring taking place as there is among junior professionals. “The hierarchies within the firms are staying largely intact,” he says.

However, as large private equity firms have expanded into new strategies and new geographies, they have had to bring on board very seasoned and very senior new partners, and the negotiations surrounding compensation in these cases have been intense, and have given rise in some cases to very generous incentives.

In expanding to new geographies, particularly Asia, private equity firms are having the most difficulties finding experienced, senior level private equity professionals to poach. The Asian private equity market simply is not mature enough to offer a large enough pool of talent with direct experience in private equity.

For every new big name that comes in, there is the risk of destabilizing the economic arrangement that has been carefully negotiated to keep everybody happy

And so private equity firms have been hiring senior talent from related pools – multinational corporations, investment banks, consulting firms.

For example, of the seven most recent, high-level Asian appointments announced by Kohlberg Kravis Roberts, only two were hired from other private equity firms. The others are senior executives from Legend Holdings, China Netcom, HSBC, General Electric, and Japan's Ministry of International Trade and Industry.

While Gonye stresses that every senior-level hiring is different, he says that in rare instances senior partners have been offered a “lookback” as an incentive to join a firm. In essence, a look-back allows a new partner to participate in the economics of prior acquisitions.

Many private equity firms have been adding operating partners – former corporate executives with managerial expertise in specific industries. While the compensation of these operating partners is typically closely tied to the performance of the portfolio companies to which they are assigned, occasionally, to attract the highest profile chief executives, some private equity firms are willing to directly share the economics on the fund's overall performance, including a share in the performance of other funds which the firm manages, such as its hedge fund, its mezzanine fund, its real estate fund, its distressed debt fund, etc. as an added “sweetener” to induce their active participation.

Such arrangements, however, are exceptions to the rule, says Gonye. “Typically, you can't compare the compensation of the non-investment partners – the operating executives – to the enormous compensation of investing partners in successful private equity. These are two very different worlds, indeed,” says Gonye.

In general, structuring senior-level compensation around the performance of particular portfolio companies is easier than bringing a new partner into the management company. Firms that seek to “fortify” their roster of senior investment professionals “find the challenge that they can't easily overcome the reality of the present, which is that this is a firm of individuals in place that don't want to readily displace,” says an executive search source. “For every new big name that comes in, there is the risk of destabilizing the economic arrangement that has been carefully negotiated to keep everybody happy.”

Whether the need for human capital expands beyond the junior ranks and into the ownership of the firm, one thing appears certain – private equity firms will continue hiring through 2007, because they will continue to raise more capital. At last month's North American Private Equity COOs and CFOs Forum, held in New York, an delegate poll revealed that nearly a fifth of the managers plan to double their fund sizes in the next fundraising. Another fifth said they were looking to bump up their fund size by 50 percent, while almost a quarter are planning to increase their fund size by 25 percent. Where the capital flows, the (well paid) people are sure to follow.