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Performance wonks

Private equity firms are applying a new rigor in evaluating the performance of investment professionals, shifting the process from an art to a science.

Like so much of the private equity industry, performance reviews were once fairly informal. One executive explained at the recent Private Equity COOs and CFOs Forum in New York that the process often amounted to the partners sitting around a table at the end of the year, tossing out names and asking, ?How'd they do this year??

Another partner at the conference admitted that often the founder or managing partners would rarely consult anyone else in devising bonuses, raises or promotions. The decisions would simply be announced, with the results sometimes standing in stark contrast to the observations of the rest of the team.

Such compensation ?decrees? are on the wane, as firms today conduct performance reviews in a far less arbitrary fashion.

Frequently, the arrival of an experienced, corporate-trained CFO to a private equity firm is accompanied by the introduction of a formal process for performance reviews. This means compiling data and observations that take into account concrete metrics and a myriad of perspectives. Many firms are evaluating professionals on the basis of not only their investment skills, but their leadership acumen as well. The reviews might take place more than once a year, but even if they are only annual, there's often a process in place for tracking their performance throughout the year. Firms are also formalizing how they evaluate their administrative teams from their HR professionals all the way down to executive assistants. Plenty of partners realize that there's too great a premium on talent to rely on fickle or informal ways for evaluating their human capital.

?As the firm grew and became more institutionalized, we knew that it was time to look at how we track performance and establish consistency in how we evaluate our talent.?

To shed some light on the ways private equity teams are instituting more robust performance reviews, below are case studies in how three firms tackle the challenge of judging their most valuable assets.

Founders Equity
Starting from scratch
New York-based Founders Equity is a buyout firm focused on the lower end of the middle market. At $160 million under management, the firm might still seem small enough to keep performance reviews in the hands of the three partners. Instead, with the arrival of the firm's first CFO in 2003, Dolores Arton, the reviews were formalized.

?They had operated successfully for roughly 30 years as a fund-less sponsor, so it operated without that extensive of an infrastructure,? Arton explains. ?But when the firm raised its first institutional fund, they brought me on board, and I started with essentially a blank slate to develop a formal approach to our performance reviews.?

The firm reviews the performance of everyone in the firm, with Arton personally responsible for the reviews of the finance team and the administrative staff, while organizing the process of reviewing the investment professionals, where she joins three partners in assessing them. ?Also some of the senior investment professionals will review the more junior team members, but we've not yet done a 360 report, though it may be something we'll explore doing in the future,? she says.

For now the reviews focus on such core competencies in the deal process as sourcing, deal due diligence and the ability to analyze exit opportunities. ?Some of these factors can be weighed with actual data from deal logs,? says Arton. The investment professionals are also judged on their ability to source debt and equity providers, which can be gauged by referring to the amount of co-investment and debt financing raised over the past year. ?We'll also occasionally speak with the attorneys or accountants who worked on a deal to get their assessment of the investment professionals' performance,? she adds.

Beyond the hard data of deal flow, financings and exits, the partners will often share their insights of working alongside the professionals. ?The tangible evidence has its place, but you can't disregard the interpersonal skills,? says Arton. She also warns that a common problem in conducting these reviews is that the recent past can dominate the picture of a given employee. To combat this bias, she aims to conduct the reviews twice a year, and will jot down notes on the various team members throughout the year.

Arton also stresses the need for not just concrete data in reviewing a given performance, but specific goals as well. On the forms used to conduct the reviews, the previous year's goals will be listed so that the employee will be judged against the expectations that have already been spelled out. ?This also gives us a chance to address the career development as part of the reviews,? she says. Arton uses the reviews to help chart the track a given employee is on, and allow them to see where they are in relation to their long term goals. ?It places the current review in the context of where they'd like to be in three or five years, and sometimes beyond that,? explains Arton.

SV Life Sciences
A little less conversation
?Over the last three years or so, our reviews have gotten much more goal-oriented and scientific,? says Denise Marks, the CFO of the Boston-based SV Life Sciences, a venture capital firm with $1.6 billion under management and offices in London and San Francisco. ?Our process used to be much more subjective,? she explains. ?It was essentially an end of the year conversation where the partners discussed an employee's prior year's performance with the other partners to determine salary and bonus awards.?

Marks joined the firm in 2003 as CFO, a role which includes tackling HR issues for the firm. ?As the firm grew and became more institutionalized, we knew that it was time to look at how we track performance and establish consistency in how we evaluate our talent,? Marks says.

SV Life Sciences created a compensation committee consisting of two of the managing partners along with Marks that reviews the performance of investment professionals on an annual basis. Each professional is evaluated by two partners, one who is the primary reviewer and another who plays a secondary role. Often these are the partners who have worked closely with the professional in question. The matrix of who is reviewing whom is issued in early November, along with self-assessment forms that allow the professionals to offer their own judgment of their performance during the past year. The results are then tallied and analyzed roughly a month later.

The firm's evaluation forms include two sets of competencies- investment ability and leadership qualities. In terms of investment skills, the firm lists categories for network and deal sourcing, managing transaction agreements, negotiations, the ability to assess an opportunity, close a deal, as well as identify and address the problems over the life of the investment.

While ?leadership? can easily become too vague a quality, the firm does its best to define exactly what that means. ?When we talk about leadership, we're assessing communication skills, time management, initiative, judgment, integrity and the ability to influence others,? says Marks. Those abilities are gauged by the primary and secondary partners reviewing them, usually by relaying specific instances where the professional did or did not exhibit those qualities during the prior year.

These reviews are then also employed to set goals for the coming year. ?We really use the reviews as a basis for setting new priorities for the professional, whether those are areas to improve or ways to capitalize on the talents that emerged in the last year,? says Marks. Those goals are arrived at through a conversation with Marks, the partners and the professional under review. ?Of course, the only way these priorities matter is if you follow-up on them in the next year's review,? warns Marks.

The 3i Group
Don't call it an upgrade
Not every firm is overhauling its performance reviews. Larger, established teams may simply be refining their process, as evidenced by the UK-based private equity manager the 3i Group, with a market capitalization of $8.2 billion (€5.6 billion). ?I'd say we've got a fundamentally similar process to what we've had when I started here,? explains Patrick Dunne, communications director of 3i, who joined twenty-two years ago.

?We have a fairly straightforward process built around clear objectives, quarterly reviews and direct feedback? says Dunne. The head of each business line whether it be buyout, growth capital or infrastructure is responsible for ensuring reviews take place in their business line and leads by example. The reviews address two core responsibilities for investment professionals at 3i: ? Investing for 3i?, which is all about deal and portfolio management, and ?Investing ?in 3i? which refers to building 3i's business and internal projects such as building a team in a given geography.

?We really use the reviews as a basis for setting new priorities for the professional, whether those are areas to improve or ways to capitalize on the talents that emerged in the last year.?

If there's been any change to the way 3i conducts its performance reviews, it's in how collaborative the process has become between teams in diverse geographies. ?We used to have teams that might have been more isolated by locale, but given the level of cross border activity, that's not the case today.? says Dunne. He explains that now when professionals are evaluated, feedback can come from as far as India for someone based in the UK. ?We're definitely gauging their ability to perform in different cultures and obviously if someone has a facility working with say, our Asia offices, that can help inform how we develop them in the organization.?

Quarterly reviews may seem labor intensive, but Dunne stresses they're a natural outgrowth of the firm's approach to communication on a daily basis. ?It's a culture of candor, where teams are put together on the basis of the best team for the job and where if someone isn't getting what they need from a member of the team, they speak up,? he says. ?The reviews rarely include surprises for the executives, as any problems or successes have most likely been voiced prior to the meeting.?

In this way, the ?candor culture? may be the final stage of evolution in evaluating performance, where the reviews are weaved seamlessly into the fabric of the firm's daily life. A process that began as an informal conversation that took place once a year might mature into an informal chat that takes place every day, though naturally no one's suggesting throwing out those evaluation forms just yet.