With falling IRRs and waning portfolios, it’s a foregone conclusion that general partners at private equity firms will not make as much money this year as they did in 2000. Carried interest, which over the past couple years has served as a huge windfall for GPs, is certain to drop given the tough exit market in 2001. Indeed, a slowing economy has put all investors’ compensation in jeopardy.
No doubt, the private equity job market will face even more change if the economy doesn’t turn around. “It’s a very different industry, the fun’s gone and there has been some trickling out of the profession,” says Adam Zoia, founder and managing director of Glocap, a provider of recruiting services to private equity firms.
However, for most private equity professionals below the partner level, compensation has been flat or higher in 2001, according to findings from a soon-to-be-released study on private equity compensation, conducted by Venture Economics and Glocap. The Private Equity Compensation benchmark report, scheduled to come out later this month, analyzes compensation data from more than 600 actual candidate placements of private equity professionals.
Since compensation for non-partner positions comes largely from fund management fees, a tough market does not impact them as directly as it does GPs. Chief operating officers and chief financial officers at venture firms, for example, are seeing the biggest gain in their total compensation, jumping 43.8% to $254,000 from $176,600 in 2000. The COO position, in particular, has become a crucial position at many venture firms, which after the gold rush of 1999-2000 are now managing billions of dollars.
Conversely, total compensation for private equity GPs (absent carried interest) is down significantly, to $265,504 from $333,546 for venture GPs, and to $284,021 from $314,314 for buyout GPs. Base salaries for VCs at the partner level are down slightly, averaging $192,464 in 2001, compared with the previous year’s average of $194,909. Buyout partners had the same experience, dropping just 0.6% to $186,191.
It’s important to note that 2001 bonuses for all positions are subject to change-so the percentage growth could end up being lower when the bonuses are actually paid out. As the chart indicates, COO/CFOs have seen only a slight increase to their average base salaries in 2001. And while vice presidents at VC firms are seeing a 31.1% increase to total compensation, their base salaries have jumped just 5.1% since 2000.
But for most non-partner positions, salaries have been noticeably higher this year. Senior associates at venture firms are making an average base of $116,437, up 12.8%. Associates have seen an increase of 6.6%, to $104,587 from $98,138, while analysts are averaging $65,720 in 2001, compared with $58,343 in 2000.
“While there was some difference in compensation among the types of firms, private equity is basically a meritocracy: Gains are made through hard work,” said Venture Economics Vice President Jesse Reyes. “Capital under management doesn’t really matter, and geography matters a little. In the end, what you produce matters the most.”
At first glance, the pay increases for non-partners might seem confusing given the dramatic downturn in private equity. But it’s important to remember that several private equity firms are managing mammoth-sized funds-that were raised before the markets began their rapid descent in early 2001. A bigger fund means higher management fees, which means more money to use toward salaries and bonuses.
Market pros point out that raising the salary of a junior staffer does not have the same negative stigma as paying higher dollars to a partner. “Partners are the ones LPs focus on, so they have to be conservative [in terms of compensation],” notes R. Michael Holt, founder and managing director of Holt Private Equity Consultants. “When it comes to junior staff, venture firms will use the management fees to boost their compensation packages in an effort to retain them.”
Indeed, with private equity firms suffering more scrutiny than ever, attracting and retaining the right people continues to be a primary concern. “Due diligence with recent hires has been very rigorous,” says Tom Hodge, COO of Frazier & Co. “We’re certainly not cutting any corners, there’s a high level of scrutiny and we’re making those extra phone calls.”
That said, a changing job market, where power has shifted back to employers, is clearly helping private equity firms keep a lid on compensation. “The power is back in the hands of VC firms doing the hiring. The entire landscape has changed dramatically, everyone’s having trouble, and the strong brand names, the more established firms, have tremendous power in the market, while the smaller firms are having retention problems,” says Rick Smith, co-managing director of Spencer Stuart’s venture capital and private equity practice.
Moreover, cost-cutting investment banks don’t pose as much of a competitive threat to recruiting and compensation efforts as they used to. Unlike years past, where buyout firms had to raise their compensation packages in order to attract associates from investment banks, in 2001 average total compensation for buyout analysts is down 18.8%, to $150,212 from $178,500. On the venture side, investment banks are less of a threat, anyway, as most analysts and associates tend to come out of consulting firms and within the industry, both of which offer less competitive salaries than investment banks, says Zoia.
Carrying On
While 2001 has brought higher salaries for some nonpartners, their overall compensation could be more vulnerable to market conditions in the future. VCs and search firms say the carry, which had been reserved for partners just a few years back, is being pushed further down the food chain-in some cases, as far down as the associate level. This trend first emerged a few years ago as competitive pressure in the market heated up and firms used it as a means to attract and retain top talent.
This practice has also proved to be quite appealing to LPs, who view aligning the interests of senior and junior professionals as a sign of good management. Frazier’s Hodge says when his firm was marketing its most recent fund, the $400 million Frazier Healthcare IV, LPs frequently asked the firm how deep the carry went into the organization.
However, it’s important to note that while carry profits have been favorable in 2000 and even into 2001, these carries reflect stakes allocated about three years ago from funds with portfolios that were liquidated between 1999 and 2000. Given the sharp downturn in the market, coupled with plummeting fund performance, carried interest shares are expected to suffer dramatic erosion going forward. And market sources say the effects of this are now contributing to fundamental changes in the supply and demand of human capital.
“The supply has increased with professionals from VC firms because they are no longer bound by carried interest handcuffs’,” says Spencer Stuart’s Smith. “With many firms reporting small and even negative returns, VCs are not really walking away from significant shares of money. The returns aren’t there.”
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