Successful private capital firms long ago ditched their spreadsheets and moved to digital tools for accounting and other middle-office tasks as part of a larger trend toward improving efficiencies, controls and operational transparency. But there’s one function desperately in need of the same modernization: compensation.
Private markets are eclipsing public markets, and the trend shows no indication of letting up. Alternative assets under management are primed to exceed $17 trillion by 2025 — a compound annual growth rate of 9.8% that far surpasses both global GDP and inflation, according to research firm Preqin.
With that growth has come increasing operational maturity and a focus on talent as a top strategic priority in firms of all sizes.
It’s not hard to see why. In alternative investments, success is driven far more by human intelligence, judgment, relationships and reputation than by algorithms. When your second-most important asset walks out the door (physical or virtual) every day, attracting and keeping that talent in-house is paramount.
Between salary, bonus, vesting, carried interest and management-company ownership, it can be nearly impossible for employees to know where they stand financially.
It’s no myth that many investment bankers at the analyst/associate level dream of going buy-side — the romantic fantasy of acceding to “master of the universe” status has long been supplanted by a less romantic, data-driven mindset drawn to the meritocratic culture (and highly accretive compensation model) of private capital.
But when it comes to attracting and holding on to the best and brightest, there’s no such thing as a slam dunk. While a talented young associate may make the lateral move to your firm with an eye on total compensation growth over time, there is zero guarantee that they will stay put until they reach the magical threshold of earning carried interest — typically, not until years four, five or six. From a retention point of view, those early years are the most vulnerable (a factor further intensified by today’s Great Resignation trend).
There’s a way to win the loyalty of the people who hold your future success in their hands. Offer them compensation transparency — 360-degree visibility into the issues that matter most to them as they chart their career — into everything from salaries, benefits, bonuses, carried-interest allocations, co-investments, past distributions and forecasting (or dollars-at-work).
Hidden costs and hidden risks
While private capital’s compensation system rewards longevity, it carries a hidden cost: complexity and opacity on top of the “predictable unpredictability” that is a hallmark of the industry.
It’s hard for an employee to know what they have, what they will have, what they might have or to understand the rights and obligations of both joiners and leavers. And in a clawback situation, where employees could be forced to pay back previously received carried interest, additional complexities and tax consequences can ensue for all.
The SEC has taken note. Commissioner Allison Herren Lee recently described employees with equity as investors “with much at stake,” who are nonetheless unable to determine the “full financial consequences of leaving their jobs” — essentially an “investment decision that must be made in the dark.”
This development is only one element of a larger story: the commission’s growing oversight of private funds, from proposed changes to its Form PF disclosure-of-material-events rules to a 341-page document of proposals focused on increased transparency at private funds.