What does the typical remuneration structure look like for a junior dealmaker in today’s market?
Watts: The typical employee will get a salary and an annual bonus that is based on performance within the year. As you progress up the organisation firms tend to try and focus people more on the long term through carried interest, share plans and the like. The bonus is sometimes attached to very stringent performance measures, but more often it is linked to discretionary performance within the year. Any carry allocation will be on top of that. What firms choose as performance measures and how stringent and tough these are for their employees to hit depends on the culture of an individual house. For junior staff the bonus tends to be driven by activity; so how many deals they worked on, and how successful were they. Firms will use fund level financial figures but they will also balance it with behavioural type measures.
What about back-office staff?
Watts: It is more typical for back-office staff to receive only a base salary and bonus. Some firms do try and incentivise back office staff with carry but that is the exception and not the rule. And it is fair to say that the levels of pay for back office staff in the private equity sector are very competitive when compared to the wider marketplace.
Mills: In terms of what they have to hit for targets, it is again a mixture of operational targets and discretionary targets. The more senior you get the more discretionary it is but lower down it is more formulaic.
How has remuneration changed in recent years and how will it continue to change?
Mills: Something that will come out more and more in the industry that has not really been prevalent in the past is the practice of telling those below partner-level at the beginning of the year what their target bonus will be, what the key performance indicators are that will drive that bonus and what the key determinants for them getting the maximum bonus are.
Up until very recently our experience has been that most private equity firms – particularly with regards to what we would call their junior investment executives – would not give any indication of what one’s target bonus or maximum bonuses would be until year end when they would be told ‘we’ve had a great year, here’s your bonus cheque’. Whereas we are now definitely seeing more formal appraisal systems linked to determinates of a bonus. And we think that is a good thing. The remuneration systems are becoming a lot more formal and transparent.
Watts: On the contrary firms exhibit a desire to avoid a box ticking mentality where individuals are just working towards their targets. In our experience several firms that have introduced a more structured approach have also left in a discretionary element. This gives them the flexibility to recognise general personal performance and, in a manner similar to that now seen in the banking industry, the demonstration of the correct brand behaviours.
Is there a worry that younger dealmakers may not see carry because some funds won’t hit their hurdles?
Watts: Some firms simply don’t allocate carry to junior staff so this is only a worry until they reach a certain stage in their career. But for firms that do, more short-term pay is being used to make up for an absence of carry payments. Interestingly the bigger houses, and especially those with the bigger brand name, are not too concerned with finding new ways to incentivise. A lot of the junior guys will be thinking ‘If I’m at the top of the tree firm-wise, where am I going to go?’ And how many firms are doing that much recruitment? The industry knows firms are shedding staff, and the market is quite dry in terms of available positions, so job security also plays its part.
Mills: I’m not going to contradict what James has just said as culture and brand are increasingly important, but that is not the presiding factor. Those factors are however key in determining why people stay where they are and why they work as hard as they do. Guys that have got into those sorts of businesses, the really big buyout firms, are generally good enough to get into the investment banks and the big management consultancy businesses. Interestingly when we ask what helps these firms retain people, culture is a big part of it, but at the end of the day money is the biggest factor.
Many firms are facing shrinking fee revenues, how does this impact remuneration?
Mills: It’s certainly been a downward pressure on pay. GPs are having to accept shrinking fees at the same time that staff levels are going up. This is because private equity houses now need more people to administer their portfolios and work for their offices, they are having to increase their compliance staff, their regulatory staff and trying to reward staff which means there is less money to go around. However in an increasingly competitive market they still need to attract the best talent, especially at the junior levels. So even though there is a belief, especially in the LBO community, that culture and carry still enable firms to recruit talented MBAs when they are setting themselves up against investment banks, money talks in getting these people and retaining them.