With practically non-existent IRRs and struggling portfolios, which of course translate into lower carried interest, it’s obvious that general partners in private equity won’t make as much money as they have over the last few years-especially those at the partner level.
However, the adjusted compensation packages are not leading potential employees away from the industry. With so many investment banks and technology companies experiencing layoffs, the supply of people is – for the first time in a long while – higher than the demand.
According to a soon-to-be-released study on private equity compensation, conducted by Venture Economics and Glocap Search, the average total compensation for private equity GPs (absent carried interest) is down significantly, to $284,021 from last year’s $314,314 for buyout GPs, and down to $265,504 from 2000’s $333,546 for venture GPs. Also at this level, base salaries for buyout pros is down 0.6% to $186,191. Base salaries for VCs at the partner level are also down slightly, averaging $192,464 in 2001, compared with the previous year’s average of $194,909. (It’s important to note that 2001 bonuses for all positions at private equity firms are subject to change, since the year is not quite over.)
While partner compensation has dropped, most non-partner salaries have been noticeably higher this year. Since compensation for non-partner positions comes largely from fund management fees, a tough market generally does not affect them as directly as it does GPs. Senior associates at buyout firms, for example, are making an average base salary of $103,750, up from last year’s $100,000, while analysts are averaging $64,125, up from last year’s $52,563.
However, taking into account the fact that the carried interest has been making its way to the more junior levels in order to retain these staffers, many partners are making up for the lack of carried interest with money from their own pockets or with more of the management fee, which is what they tried to get away from in the first place when they began offering the carry to junior staffers.
Though carried interest will take a hit this year, sources expect its descent to the lower ranks to continue. The reason for this trend is twofold. It started when buyout firms began raising larger funds, which occurred at about the same time as the technology boom. GPs needed to lure bright people away from the draw of stock options and high investment banker salaries by dangling the carry carrot in front of them. Additionally, limited partners began trying to align the private equity professionals’ incentives with their own and encouraged GPs to stop paying employees such large salaries out of the management fees and start letting them in on the carry. LPs thought using management fees to boost salaries was a perversion of the intention of the fee, arguing that it should instead be used on analysis put into investments. And whatever LPs say usually goes, considering they are the lifeblood of private equity firms.
But today, with the lack of carried interest, GPs are back to paying bonuses and increasing salary packages with money from management fees – a partial explanation for why associate and analyst salaries are not lower this year.
Adam Zoia, managing partner of Glocap, attributes the effect on salaries not only to the above, but also to the fact that the source pool for candidates is shifting to include operating professionals that aren’t used to making millions.
“The operating environment has become more difficult, and the people with hands-on experience are proportionally more valuable than people that just have financial skills,” says Zoia. “But the pay scale of people coming out of industry is lower than the pay scale for people coming out of banking or fresh from an M.B.A. program.”
With no reprieve in sight for the current economic environment, the pay scales are likely to stay at the same level. As GPs deal with distressed portfolio companies, they tend to put operational experts in place to bring the companies back to life.
Indeed, the CFO and COO positions, which are not distinguished between in the Glocap study, saw the highest percentage increase in base salary out of all the private equity professionals. At buyout firms, base salary for the CFO/COO increased to $135,833, up 6.9% from 2000’s $127,000.
Ernest Jacquet, co-founder of Boston’s Parthenon Capital, has increased his staff from 14 people to a current 35. He agrees that the focus on operations is important and calls the new millennium the “era of earnings growth,” whereas the ’80s were the era of leverage and the 90s were the era of multiples expansion.
With all his hiring lately, Jacquet has seen firsthand the adjustments that have been applied to compensation during that time period. His firm adjusted up all its employees’ salaries and bonuses to retain them in 1999, even when the difference came out of his and his partner John Rutherford’s pocket. In jest, Jacquet says he tells his staff that because everybody was moved up during the good times, they should all be moved down during the bad times. Not surprisingly, the staff doesn’t usually laugh at that joke.
Nonetheless, it’s obvious that operating partners are in demand. In addition to Parthenon’s rush to hire these experts, other firms recently bringing them on include Brentwood Associates (see story Brentwood Cozies Up to Operations), Morgenthaler, Audax, Crescent Capital and Sun Capital, just to name a few.
In essence, the adjustments to compensation packages have not hurt the recruiting and retaining efforts of buyout firms. While hiring has unavoidably slowed down, just like the economy, Michael Holt of Holt Private Equity Consultants says firms are not having trouble attracting employees based on salary. Moreover, there are a number of smart, savvy people who have been laid off from investment banking jobs and are thus available.
“There will always be competition for the best people, even in the worst of times,” Holt says.
Conversely, Holt, whose firm specializes in private equity organizational and human resources issues, including carried interest and co-investment plans, says he is not as busy as he would like to be, which points even more definitively to the fact that hiring has curtailed.
“Everything is a cycle,” he says, “and it will all come back.”