The private equity industry has reached a new level of maturity and sophistication in recent years: record fund sizes, all-time high entry valuations, more comprehensive value creation strategies and deeper sector expertise.
As many veterans acknowledge, it is also a harder game to play than before: targets are more eagerly mapped by all and certainly more transparently valued, and whilst there are many more firms fighting for dealflow, there are not necessarily many more suitable businesses to invest in. To win means paying up and working even harder during the ownership phase to sweat returns more than ever.
The modern environment is driving attitude and behaviour changes. For more experienced investors, still in the ‘under 40’ bracket and holding meaningful track records, one perennial challenge is finding space to grow within their firms when incumbent partners are not rotating out. The last five years have seen many people take advantage of available capital sources to step out and start their own fund as one way through the glass ceiling, trading the security of their former employers for independence and autonomy.
Quite how this will look post-coronavirus will be intriguing to observe, and as ever there will be very different perspectives between those who have locked in 10 years or more of management fees and those still trying to fundraise or operating on a deal-by-deal basis.
Opportunities for advancement
We have observed how firms have reacted to this exodus, with the best examples showing creativity and flexibility in creating new roles and positions to enable high performers to remain and continue to progress – for example offering mobility to emerging markets in leadership roles, enabling internal transfers between fund strategies or instigating dedicated in-house specialisms such as head of financing, sourcing or value creation.
There will always be a certain proportion eager to run their own shop but we believe some of these responses by the funds have indeed boosted retention of the next generation of leaders and we expect to see more examples to come.
Mid-level investors have been in great demand among our clients in the last few years as firms seek to boost their engine rooms and expand into new territories, giving opportunities for talented investors to move on from less welcome cultures. Many funds, especially larger ones, are now highly institutionalised and, as such, cultures that were once agile and dynamic threaten to slip into a more corporate style without careful and deliberate nurturing. If individuals do not feel enough proximity to real decision making or are unable to see the influence of their own direct contributions, this begins to feel like just a job rather than the risk-seeking wealth-creation machine individuals saw when they were starting their private equity career.
With carry allocations still skewed to founders and with high entry valuations possibly knocking out arbitrage opportunities, the financial motivation of future carried interest payments loses some of its power. Having worked for results and recognition from their partner group and now getting an informal green light that they are seen as being ‘on partner track’, some high flyers are now asking themselves whether they in fact want it after all, especially when there seem to be so many opportunities for lateral moves to other funds.
How should the employer handle this? We believe the answer here, as in so many other situations, is cultural. Of course, setting compensation at competitive levels is important and having an equitable internal structure is key to retention, but these are not substitutes for treating people with integrity and consideration and the firm that relies only on cash will not sustain. Now more than ever, individuals are also driven by non-financial factors such as transparency of decision making, diversity, environmental, social and governance policies and the level of emotional intelligence of the leadership.
At PER, we define culture simply as ‘how we do things round here’ and these ways of working really do matter to retention; saying this is not just an attempt to ingratiate ourselves to the younger generation, but recognising they make a difference in a tight labour market. To give one real, concrete example of a mid-level person who switched firms a little while ago: “I don’t mind working incredibly hard; I can live with the fact that short term I am probably underpaid relative to my peers elsewhere; I can even handle the fact that my boss treats me like dirt from time to time. But when there’s no recognition or career advancement, I have had enough – I’m off.”
“Now more than ever, individuals are also driven by non-financial factors”
Expect to see a greater emphasis on managing this middle layer of the investment team. Traditionally, private equity has not often shown itself to be that progressive on internal HR matters and has generally defaulted to a sink-or-swim approach to handling talent, but change is coming. The tip of the iceberg is perhaps the hot topic of recent years – trying to get more diversity into the industry. Again, we see differing levels of commitment to this – some paying lip service to the issue and others really challenging themselves to rethink how they hire and develop people. I believe this search for solutions will extend into other areas to address employee welfare and career expectations.
Social media now gives individuals the chance to compare notes and diligence their own employers, both on the way in and on an ongoing basis and firms need to show a level of pre-emptive reputation management. The requirements are for better listening, anticipation and possibly greater humility among leaders. We are starting to see HR teams impacting in these areas and achieving the sort of upgrade and recognition that investor relations teams have in the last decade.
Just another job, for some?
For the youngest part of the market, including recent and upcoming associates, one striking trend is how many do not even expect to stay in the industry, let alone their current firms, for more than four to five years. We see a significant minority of this group, maybe as much as a third, who view this as a stepping-stone: ‘I’ve done some banking or consulting, I’ll do a bit of private equity and then I’ll do something else.’ This perspective points to the increasingly institutional nature of the industry now, even as it contradicts the whole ethos of long-term investments and the mindset of earning carried interest. Firms clearly need to identify and nurture those with stronger long-term commitment, but there is still a place for others not expecting to stay and they, perhaps, need to be managed and rewarded differently.
There is much speculation about whether coronavirus will have a lasting impact on hiring and retention within private equity. Based on our market dialogue, we believe demand for talent will remain high, indeed higher than supply, and at all levels. The firms we have seen handle this best focus both on retaining the talent they have invested in and attracting new hires through differentiating themselves in the market.
This all requires a new way of managing growth: avoiding the development of an over-institutionalised corporate culture and maintaining the entrepreneurial spirit and ambition that makes private equity unique.
Rupert Bell is principal consultant and head of DACH at private markets recruitment firm PER.