News & Analysis

Re-imagining carry: Should they stay or should they go

GPs and LPs alike are starting to mull new approaches to compensation and incentivisation. In the final installment of a three part series, Zoe Hughes discusses splitting a fund's assets into good deals and bad deals - with only the good deals included in carry calculations.

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At some stage all parents have to accept the fateful day when their children will fly the nest. It is a fact of life and a law of nature, irrespective of species.

It is also a fact of finance, with firms continuously hiring, training, promoting and rewarding their professionals throughout their careers, often to see them later spread their wings by joining another firm or branching out on their own. During better economic days, such regeneration among the ranks could be spun in a positive light, allowing the firm the chance to renew itself with fresh blood and new ideas.

Hughes

But for private equity firms today, such upheaval is unwelcome. Faced with challenging legacy assets, a slow fundraising market and difficult debt markets, many GPs need as many experienced hands on the deck as possible. Yet, it is in precisely such circumstances that GPs, and their staff, also face the real prospect of earning little for their efforts.

Few people, if any, are happy to work for little or no pay and it is an issue PEM has written about on numerous occasions. So how do GPs – and the limited partners in their funds – continue to incentivise the team, ensuring the platform can survive to fight another day?

One radical solution to have surfaced in the past month would see GPs and LPs agree to split an existing, partially or fully invested fund into two pools of assets – one containing the good deals and another containing the bad ones. 


Dividing a fund into a “good bank/bad bank” would have the benefit of allowing GPs and LPs to concentrate on those investments with the best chance of making a profit, and give the GP team the opportunity to earn carry on the better deals. 

This solution and others like it, of course, raise enormous questions, not least why an LP should reward a GP for failure. If LPs have to take the hit, so too should their GPs. To date the idea is just that, an idea – and it will likely remain so in the future.

In deciding how to incentivise a GP team it’s worth asking one question: is the current make-up of the GP team appropriate to face the challenges of today
and tomorrow? In essence, is the status quo actually necessary?

It’s also worth asking another question: is the current make-up of the GP team appropriate to face the challenges of today and tomorrow? In essence, is the status quo actually necessary?

What a fund requires at the start of its life from its key executives and wider GP staff is different to what it needs in the middle and at the end of its life. Add to that equation a global recession and downward pressure on private equity's fundraising capabilities, and a GP’s team from five years ago may need a facelift to fit into the world of 2010 and beyond.

There is no one-size-fits-all-approach.

Clifford Chance fund formation partner Roger Singer

As Clifford Chance fund formation partner Roger Singer explains: “No one thinks it’s a good idea to have someone not getting paid to manage a fund, but neither should anyone be blindly preserving the team.”

For Singer, the debate on team retention is an opportunity for investors – as well as fund sponsors – to think about exactly what they want from their GP staff. “There is no one-size-fits-all-approach,” he says. LPs should be focused on maximising value from today’s opportunities – and deciding the GP team best suited to execute those strategies.

It’s wise to remember, after all, that not all parents watch their children voluntarily leave the nest. Some also have to give them a push – which isn’t always gentle.