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PE & VC News

Pay in the private equity industry is on the rise. As is always the case in a highly competitive, human capital intensive industry, the question is: pay is on the rise for who?

Looking at Some Broad Pay Issues

Consider, for instance, the situation of Blackstone CEO Stephen Schwartzman.  His annual base pay is $350,000, and it hasn’t changed since Blackstone’s initial public offering in 2007.  The tale of flat base salary is quite common in modern day finance, at least among individuals responsible for running financial firms.

What’s more interesting than the flat base salary is the enormous growth in bonus pay. Mr. Schwartzman’s total compensation in 2014, which includes an annual bonus, dividends, and equity incentives, is at about $690 million, and may reach more than $1 billion by the end of the year.  Not bad for a guy who has a base salary of a mere $350,000.

Hollowing Out of the “Middle Class” in Finance?

The story of Mr. Schwartzman is something that’s becoming increasingly commonplace in the financial industry.  Pay is shifting towards incentives, and the individuals benefiting from such a switch are head honchos and young Wall Street talent.

The middle group -well, they might be in trouble.

Pre and Post Crisis Pay

Here’s a look at New York City wages from 2007 to 2014.

As indicated, 2014 post-crisis pay in the Securities sector is still below where it was in 2007, down from $436,792 to $426,149. Interestingly, although not surprising, pay in the “All Other” category is up, from $70,783 to $73,313.

Why is the securities industry lagging, or is it?

New York City wgaes.fw

The answer, according to compensation experts, is that pay in the securities industry is undergoing a transformation. Instead of paying employees a flat annual salary, Wall Street firms are shifting more pay towards cash bonuses, and this shift benefits the higher-ups and the newly hired.

Equity-based Deferred Compensation

In addition to using cash bonuses to attract talent and reward top performers, Wall Street’s top brass also have a greater share of their compensation coming from equity-based deferred compensation.

This equity-based deferred compensation is what makes Mr. Schwartzman so much money as well as other top Wall Street CEOs.  Their six or seven figure salaries can easily shift to 8 or even 9 figures when performance based pay (i.e. equity-based deferred compensation) has value.

Other Shifting

In addition to a shift to cash bonuses and equity-based deferred compensation, Wall Street is also looking for younger talent and talent outside of the New York area.  Wall Street firms are also letting mid-level employees go in an effort to boost profitability.

Conclusion

Perhaps unsurprisingly given the increasing mobility of labor and firms willing to outsource labor to lower cost areas, there’s a growing gap between the lower paid private equity industry employees and the higher level employees.

Part of the shift can be explained by outsourcing and downsizing.  Part of the shift is also due to a shift towards cash bonuses and equity-based deferred compensation.

There is also no indication that the gap will be narrowing any time soon.

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By most measures, 2014 was a fairly positive year for the private equity industry, in particular early stage private equity (typically known as venture capital). The relatively decent performance of private equity over the past few years has some analysts wondering whether the industry is approaching a business cycle peak. The concern for an industry peak only heightened recently when looking at the enormous valuations some later-stage startup companies are receiving.

Could 2015 turn out to be the peak year for the industry?

Venture Capital Commitments

Here’s a look a venture capital commitments from 1985 to 2014 (an interactive version is available here). Does it look like the investor – the one who puts up the capital commitment – is thinking the industry is peaking? Probably not.

The figure is divided into four quartiles.  The first quartile is the lowest 25% of the sample.  The gray area between the lower quartile and the median are the 25th to 50th percentile years.  The light gray area between the median and upper quartile are years in the 50th to 75th percentile of venture capital commitment years.  All years above the upper quartile are years when commitments were in the upper 75th percentile of all years.

The Tech Bubble and Housing Bubble

It’s impossible to miss the technology bubble, peaking, in terms of venture capital commitments, in 2000 at $101 billion.  The years around 2000 were not too shabby either at $54 billion and $39 billion. Interestingly, the 2005 to 2007 period also saw commitments reach the upper quartile, with the height occurring in 2006 at $31 billion.

Today’s Commitments

Fast forward to today’s situation. It’s hard to argue, at least when looking at the historical experience, that the venture capital industry is in the middle of a bubble.

Sure, the industry continues to receive commitments growing at annualized double digit growth rates, but the double digit growth rates are nowhere near enough – yet – to bump commitments made by investors to the venture capital industry into the upper quartile.

How far away are commitments before the upper quartile is reached?

Total venture capital commitments came in around $20 billion in 2014.  The upper quartile starts at $26 billion, meaning that the 2014 commitment figure is 30% below any potential “bubble” indicator.

Bottom line: the industry has some room to grow before any concern about a commitment bubble is reached (valuation may be another issue, although the two are somewhat connected).

Venture Capital Commitments Looking at Venture Capital Commitments as a Percentage of Total Private Equity Commitments

Simply as further inspection of whether the venture capital industry is peaking, here’s a look at the venture capital industry’s take of the total private equity investing pie. As shown (an interactive link is available here), venture capital’s take is still below average at 24% (the historical average is 28%).

Fascinatingly, the venture capital industry’s take peaked in 2000 at an astounding 56%.

Venture Capital - Pctg of Total PE

Conclusion

Overall, 2014 was a strong year of growth for most stages in the private equity universe, including early stage venture capital. In looking at the historical cycle of venture capital commitments (in both absolute dollars and as a percentage of total private equity investments), the industry appears to have a good deal of growth left before any discussion of a peak is useful.

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There has been lots of chatter recently about the strength of the U.S. employment picture. The early March knockout employment report, at +295K net new jobs, seems to have increased the discussion about whether the employment picture is peaking.

Is it? How much longer can the labor market keep accelerating?

(As a note, acceleration means that the rate of the year-over-year growth rate continues to increase.)

The Month-over-Month Employment Picture

As background, here’s a look at the month-over-month employment picture. Since bottoming in the fourth quarter of 2013, the U.S. labor market has been on a tear, gaining more than 200K jobs since February 2014.

The strongest month over the period occurred in November 2014 at an amazing 423K. The weakest month was in August 2014 at +213K.

What’s clear when looking at the month-over-month figures is that U.S. job market growth has experienced a marked improvement from the lackluster growth years of 2012 and 2013.

mm jobsThe Year-over-Year Look

Although Wall Street analysts tend to prefer the month-over-month growth figure as their measure of strength in the U.S. jobs market, many economists opt for a somewhat less tangible figure, year-over-year growth.

Here’s a look at the year-over-year growth in U.S. jobs since 1971. Notice any behavior that is close to today’s labor market picture?

Two prior experiences stand out when comparing with what the U.S. labor market has done since February 2014. The experiences are 1986 to 1988 and 1996 to 1998.

The Acceleration Period

First some explanation.

The gray area in each chart is the mid-cycle acceleration period.  It is the time frame in which the year-over-year growth in employment accelerated consistently.

The yellow box represents the period after which the acceleration ended, which here is called the “cruising speed” period.

As shown, the economy experienced a mid-cycle uptick from June 1986 to March 1988, a total of 21 months. A similar mid-cycle uptick occurred from January 1996 to January 1998, a total of 24 months. The current mid-cycle uptick has lasted 12 months.

So, if the past two experiences are any indication, the current mid-cycle strength has another 9 to 12 months of acceleration left.

Cruising Speed

Following the acceleration period is cruising speed. As shown in yellow, the time spent in cruising speed can be somewhat short to relatively long.

After reaching cruising speed in 1988, the economy stayed there for about 11 months. The experience after peaking in 1998 lasted 28 months.

yy empConclusion

Overall, although there’s lots of chatter about a potentially peaking U.S. employment picture. If one looks at the past two similar experiences in the U.S. labor market, the chatter appears to be premature. There’s lots of time for the labor market to continue to impress.

The strength or boom period has another 9 to 12 months to go, while the cruising speed has another 11 to 28 months to go.

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Is the Tech Industry in a Bubble?

February 23, 2015

Recently, chatter has focused on whether the technology industry is in a bubble.  Is it? Individuals following say, home prices in San Francisco, one might get the impression that it is.  Since bottoming in January 2012 at about $621K, the median home price in the Bay Area is now approaching $1.1 million, a growth of […]

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2015 Chicago Booth Private Equity Conference

February 18, 2015

This Friday is the 14th annual Beecken Petty O’Keefe & Company Private Equity Conference. Each year, the private equity conference focuses on a unique theme through a series of fireside chat and panel sessions with various industry experts. This year, the conference’s theme is “Return Realization: Positioning and Timing the Ideal Exit.” The conference will […]

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A Record Year for Private Equity Buyouts

January 26, 2015

Pitchbook is out with initial estimates on the number of venture capital exits via private equity buyouts in 2014. Perhaps surprisingly, the figures show some incredible strength. Initial estimates put the number of private equity buyouts via venture capital exits at 138, an increase of about 25 percent from 2013. Private equity purchases via venture capital exits […]

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When Will the Oil Price Drop Show Up in the Labor Market?

January 12, 2015

The private equity industry is, surprisingly, closely connected with movements in the oil market. Part of this certainly stems from macroeconomic forces and their effect of the private equity business as a whole. Another part stems from the massive involvement the private equity industry has in putting together deals for the oil and natural gas industry. Given […]

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Some Highlights on Job Search Digest’s Private Equity and Venture Capital 2015 Compensation Report

December 29, 2014

Job Search Digest recently released their 2015 Private Equity and Venture Capital Compensation Report.  In it is a great deal of detail about how firms reacted to the changing market conditions in 2013 and 2014.  Among the various interesting findings, here are three. Job category with Highest Bonus as a Percentage of Total Compensation Of […]

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A 2015 Outlook for Private Equity Jobs

December 15, 2014

2014 is coming to an end.  With the year almost over, it seems fitting to review h ow private equity employment did through the year and what we can expect for the year ahead. A Look Back at 2014 – Actual Employment The following is a look at total private equity employment since 1990.  Overall, […]

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Recent Survey Results on Environmental and Social Governance of PE Firms

December 1, 2014

Pitchbook recently released some interesting results of its environmental and social governance survey of PE firm policies.  The following is a review of some of the more salient points. Existance of an Environmental and Social Governance (ESG) Policy First, Pitchbook asked the 104 general and limited partners whether their firm had an ESG policy. Unsurprisingly, from […]

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