The private equity industry continues to expand in terms of capital under management and head count. Deal teams are getting larger, investments are becoming more complex, and LPs are showing greater interest in the contributions of individual investment professionals, as well as the mechanisms in place to retain talent.
One particularly sensitive issue involves assigning deal professionals credit for their work on deals. How a deal pro contributed to a deal – to its sourcing, its due diligence, its structuring, negotiation, talent recruitment, monitoring, business enhancement and exit – can and should affect the compensation and career path of said deal pro.
But human nature and GP ego dictate that success has many fathers and failure is an orphan. As such, it is important for private equity firms to carefully document who did what at each stage of a deal or risk conflict down the road.
Regarding deal attribution in particular, it seems as if there are as many ways of tracking this activity as there are GPs active in the market. The approaches adopted by most GPs tends to mirror the general level of complexity involved in managing the affairs of a firm, which is in turn closely linked to the size of the firm. To shed more light on the art and science of managing deal attribution, this article examines how one very small firm and one much larger one address this issue, as well as how GPs' method of tracking deal attribution plays into investors' decision to commit to their funds.
According to Dan Bathon, a founding partner and chairman of Lexington, Massachusetts-based venture capital firm Windspeed Ventures, the size of his firm makes it more sensible to adopt an all-for-one, one-for-all approach to tracking deal attribution – in other words, to not track it.
?If you get ten or more investment professionals, it is difficult for all of them to be involved in every deal. In a three-partner firm like Windspeed, we do not attribute the deal to a particular partner, and instead pull each partner's talents into the deal,? says Bathon. ?That's a better model for us and gives us the right team approach. We wouldn't want a partner to be so focused on his deal for attribution that he wouldn't help another partner on a deal.?
As an example, Windspeed founding partner Steve Karlson points to the firm's investment in VistaPrint, an online supplier of graphic design services and which completed a $138 million IPO last September. Karlson sourced the VistaPrint deal for Windspeed and sat on the company's board of directors. However, he emphasizes that the entire partnership was involved in the due diligence process prior to making the investment, and other partners would substitute in for Karlson at the board meetings he was unable to attend or provide useful contacts that he did not have.
?All of that is perfectly fine with our partnership because we don't have specific attribution or economic advantage based on the effort put in the deal,? says Karlson. He notes that an added benefit of having such a structure is that the management teams of Windspeed's portfolio companies are able to get to know all three of the investing partners.
?It's like parents sharing responsibility for a child, with all of the partners equally concerned about each asset,? says Windspeed's Bathon. ?In terms of the partnership, it is still wiser to treat everything equal among us.?
However, Bathon and Karlson say that the firm would contemplate adopting a different approach to attributing deals as Windspeed continues to grow. ?We would consider institutionalizing the process once we reach $300 million or more in total funds raised,? says Karlson. ?At this point in time, we are under the $200 million mark. So it might be out there in the future.?
At the opposite end of the spectrum from smaller venture teams like Windspeed is Boston-based private equity firm TA Associates, where not only are deal attribution records meticulously kept, but those records are also heavily relied upon for determining compensation for TA's investment professionals.
TA Associates, which has roughly $5 billion under management, does systematically track its investment professionals' contributions to deals. According to Kevin Landry, chief executive officer of the firm, out of TA's 81 employees, all 25 full-fledged investment professionals are tracked, while the firm's 15 associates are tracked at a different level.
?The type of people who join our firm say it's a meritocracy.?
?As every deal is closed, a sheet goes around, and everyone signs it and writes down who did what,? says Landry. ?It's quite precise, the allocation never changes in future, and it all takes place with the deal close.?
At TA, most of the credit is generally assigned to the ?sponsor? and ?co-sponsor? for each deal, with the sponsor usually receiving 40 percent to 50 percent of the credit, the co-sponsor 30 percent to 40 percent, and an average of 5 percent for each of the two managing directors who serve on the investment committee for the deal.
Key efforts that are recorded include who sourced the deal, who did the work on the deal, who arranged the lending, and who carried out the negotiation. ?We leave it up to the people involved in the deal to work out among themselves,? says Landry. ?They know intimately who did what. People are cooperative, and this is not something where there is a lot of sparring. In any case, no one knows yet how the deal will do.?
The attribution records do have a significant influence on compensation at TA. For the firm's investment professionals, the year-to-year base salary typically makes up 40 percent of compensation while the rest is made up of bonus compensation.
According to Landry, TA's system of deal attribution has been in place for some 15 to 20 years and arose from the firm's needing a means of measuring performance. ?Back when we were set up in the 1960s, deals were generally done by one person, and there was a more simplistic approach,? recalls Landry, who has been with the firm since its inception in 1968. ?Now, with more shared work on deals, the current system has evolved.?
?I think we do a much more extensive job of tracking this. The type of people who join our firm say it's a meritocracy – it's not entirely objective but close,? says Landry, adding that he does not expect TA to dramatically alter its system any time soon.
In addition to its usefulness for internal assessment of investment professional performance, deal attribution records are also a key part of LPs' due diligence on potential investees. How institutionalized the deal attribution record-keeping practice is ranges ?all across the board,? observes Kathy Wanner, a partner with the funds of funds group of Chicago-based Adams Street Capital.
?Some GPs are very, very good at tracking partner attribution which is used for communication with their LPs and internally for a variety of reasons including compensation. Others say they have a team-based investment approach, where everyone participates in the deal and do not attribute individually, at least not for purposes outside the firm,? Wanner says.
?For firms that are on Fund 4 or 5, you'd expect they would have this information pretty well put together,? says Joncarlo Mark, senior portfolio manager at the alternative investments unit of the California Public Employees Retirement System, the largest US public pension fund. ?On the other hand, it could be different for a hot new venture fund; first of all, they might not even be going out to new investors.?
And, although a rarity, some smaller, more ?elite? funds may not necessarily put together the diligence material because perhaps they feel their partners know them already, adds Mark.
At the end of the day, LPs look at the deal attribution system as merely one part of their investment due diligence and find it most useful in identifying which people at a private equity firm create the most value and how this talent is retained.
?We look at the competitive advantage of a firm, its relative franchise strength, and organizationally related factors,? says Wanner. ?It is the combination of these three areas that leads us to understand the firm. Performance attribution would fall under the last two, but it certainly would not directly lead us to invest or not invest with a group. But we want to understand it, in terms of where the value in an investment was created.?
And at times, the clichéd ?less may be more? may apply, particularly if it signals a cohesive corporate culture, according to some LPs. For Adams Street, what counts most is the deal team as a whole. ?If everyone works together, the firm ends up in a better place, rather than a star system where just one person is driving the deal,? says Wanner.