How are PE firms vesting their carried interest?

30% of professionals said that their vesting schedule lasts more than five years, according to a survey by Heidrick and Struggles.

More than two-thirds of investment professionals that are eligible for carried interest receive their carry through straight-line vesting, according to a report by Heidrick and Struggles.

Straight-line vesting is when an employee receiving carried interest does so monthly over a certain period of time.

Fourteen percent of the professionals surveyed said they have a cliff vesting schedule, in which carried interest is not received until a set time period. Other responses included time-based vesting, realization upon exit or a mix of partial straight line followed by a cliff.

Longer vesting periods are potentially beneficial to private equity firms as a way of helping retain employees.

“The longer your vesting schedule is, the more likely people are to stay,” Blinn Cirella, chief financial officer of Saw Mill Capital, told pfm.

In the report, 30 percent of professionals said that their vesting schedule lasts more than five years and 15 percent said it is more than four years. Interestingly, 16 percent of those surveyed said that their firm has no vesting for them, which Cirella feels could be an issue for the firm.

“You would not want no vesting,” she said. “This would create a situation where someone, let’s say a vice-president, who is employed for maybe a year or two, leaves the firm. If there is no vesting, they will get full carry on the fund through the life of the fund even though they don’t work at the firm anymore. That hardly seems fair to the employees who are still at the firm and working hard to make and grow the investments.”

All principals, partners/managing directors and managing partners said they receive carry, but more than two-thirds of associates/senior associates said they do not. However, some firms do offer carry to a wide-range of employees, which limited partners generally don’t have an issue with.

“Most LPs are indifferent in terms who receives carry, although they would like the key investment personnel receiving the bulk of the carry,” said David Fann, the co-founder and president of investment advisor TorreyCove. “Some firms have gone deep where associates, analysts and even administrative staff have received carry.”

Like most situations, there are pros and cons in offering carry to many different employees. Vesting schedules can act as a great way to incentivize employees to work harder and stick with a company.

“The negatives are in those situations where there is a clawback issue and asking lower compensated employees to repay carried interest payments previously received,” Fann said. “Also, associates and analysts tend to leave more readily, so collecting a clawback from a departed employee is often challenging.”

Clawbacks can get messy, even on the firm side. In 2016, Carlyle paid $47.3 million in clawback related to its Carlyle Asia Partners II fund, pfm reported last year.