A digital transformation is sweeping through compensation and carried interest 

PE firms are discovering how transparency is reducing risk and redefining competition in a world of heightened regulatory scrutiny and tougher employee retention, writes Richard Change of PFA Solutions.

In private capital, employment and investment often converge as one. That’s why transparency in compensation and carry has evolved into a major differentiator that can give the smartest, most innovative firms a competitive advantage.

The big caveat here is that transparency often comes with a heavy resource load. Private equity, venture capital and similar industries that regularly use legacy systems may not be equipped to handle a transition to digital platforms – even when their decision-makers are committed to providing their professionals with the information they want and need about remuneration. Digital automation is key to making this transition work smoothly.

Yet many PE firms still operate on non-automated legacy systems (think: reams of spreadsheets). In the age of fintech, one would think that such manually produced work documents would make for nostalgic memories in PE. But in actuality, they constitute the bulk of what powers current PE operations. Like a hypothetical encounter between a medieval army and a mechanized force, the spreadsheets may score points in retro-simplicity. But when deployed properly, the fintech wins hands down.

Transparency as a retention tool

SEC officials recently began proposing a series of expanded regulations in the private capital markets that is expected to bring forth a sea change in the industry. Among the proposed regulations are heightened reporting procedures, including additional quarterly reports and same-day reporting of significant material events and detailed accounting of “performance based compensation,” or carried interest.

If legacy PE processes are already straining in a high-pressure environment, imagine the added friction and risks that an increase in reporting requirements might impose on firms’ already overstretched resources.

Importantly, these new rules aren’t designed simply for investors. They’re also intended to protect employees in companies who don’t just receive typical base compensation and standard benefits, but are eligible for earnings from carried interest, profit-sharing, co-investments and ownership.

Transparency about compensation and carried interest, in other words, is a retention tool. PE firms that can provide their professionals with more information and insights into these benefits will become more competitive vis-à-vis talent than those who can’t. With that in mind, consider the following areas where PE firms may soon find themselves in stiff competition.

Comp and carry in recruitment and retention

Imagine you’re a potential candidate choosing between two equally attractive PE firms offering similar compensation. The big difference between the two is that one offers you “at-your-fingertips” access to a wide spectrum of compensation details. Moreover, the information is available through a cloud-based digital solution that you can use securely on your smart device or laptop.

Not only are you able to view your salary, bonus, healthcare reimbursements and all other standard perks, you can also access a detailed breakdown of your carried interest awards, co-investments and any other forms of company ownership on the horizon.

Even better, the firm’s system provides a detailed forecast of your future earnings. Your compensation, carried interest payments and every other form of investment and ownership income is projected in advance. You can see the current and future value of your employment-slash-investment in the firm.

Now, suppose the other competing firm can only provide the above information on an incremental basis or upon request, but with a reasonable delay. Comparing the two, which company might provide more value to you as an employee? Which firm is a better “investment” of your time?

Constant access to data, documents and operations

If the pandemic taught us anything, it’s that firms operating without a virtual portal are uncompetitive at best and possibly flirting with terminal risk at worst. There isn’t much of a comparison between open and immediate access and limited access to workflows and data.

Given a choice, employees in the PE industry – especially younger employees who take online work for granted – would rather opt for an environment where data, documents and collaboration can remain operationally fluid despite geographical boundaries. This access, of course, includes compensation and carried interest activity. After all, both represent employees’ primary interests towards and investments within the firm.

Automated enterprise analytics give leverage to lean operating teams

While the pandemic and Great Resignation have impacted every company, firms operating with heavy data loads take the brunt of the damage if they lack the staff necessary to keep running smoothly. Private funds that have resisted innovation in the digital realm are among those who have struggled to adapt to the new normal.

Aside from maintaining core operations, compensation and carried interest activity became burdensome for teams running with lean capacity. Companies equipped with “push-button analytics” and other digitized processes are arguably in a better spot for delivering information to professionals than those relying on non-automated spreadsheets and other manual execution protocols that are outdated in the fintech age.

A unified comp and carry system tackles all three pain points

To transform compensation and carried interest activity into an incentivized work benefit, automated software is a must. Automation allows firms to efficiently calculate, update, store and present a vast range of compensation data on demand – a level of radical transparency that allows employees to see where they stand earnings-wise and where they’re going.

Legacy systems simply won’t cut it in this accelerated environment. Many firms view transitions and related costs as a risk and hassle. But digitization today, from the most basic employee portal to the most sophisticated co-investment analytics, can be implemented seamlessly. However they’re rolled out, digitally automated compensation and carry systems are an exit portal for legacy systems that can’t hack the pace.

Richard Change is co-founder and managing partner of PFA Solutions.