What is carried interest? And who earns it? Carried interest, also known as “incentive allocation” or simply “carry,” is the percentage of fund profits charged to the investors as an incentive fee (on top of management fees). Carried interest is the proverbial “carrot” that keeps PE fund general partners striving for better performance.
Most funds typically allocate around 20 percent of the funds profits for carried interest. But the recent turmoil in the markets and less-than-stellar performance figures have put downward pressure on this benchmark over the past two years.
How is carried interest distributed among PE fund professionals? Unlike the hedge fund industry, where 70 percent of a fund’s staff may not receive any upside on performance, 52 percent of private equity professionals reported that they received some level of carry. That’s according to the 2010 Private Equity Compensation Report, published by JobSearchDigest.com
How is carry shared?
27 percent of Associates and 48 percent of Senior Associates reported receiving some carry, although typically at a level of 2 percent or less. Those with carry reported having a holding period of roughly 4 years before they were fully vested in their carried interest.
Perhaps the greatest indicator of whether you will receive carry at a PE firm is how much work experience you have. More experience translates into more senior positions, thus greater carry. The majority of private equity professionals with 10 years or more of work experience have some level of carry as part of their compensation package.
You can read the full 2010 Private Equity Compensation Report at
www.PrivateEquityCompensation.com
Specialists and those with experience in emerging markets are among the most sought-after candidates for the few private equity jobs opening up this year. That’s the word from the Wharton Private Equity Conference which kicked off this past week.
Aditya Joshi, co-chair of this year’s conference, will be heading back to his home country (India) after earning a Wharton MBA this May, according to an article in the Wall Street Journal online. Joshi said he’s seeing a continuing trend of students gaining PE training here in the U.S., and bringing that expertise back to Brazil, India, China, or Eastern Europe. Nearly half of Wharton’s students are international students.
“We’re seeing more interest from emerging markets private equity firms to bring people who have strong private equity and financial experience to those regions,” said Jonathan Goldstein, a partner with the recruitment firm Korn/Ferry International.
In addition, specialists with backgrounds in alternative energy and growth equity deal origination are in demand.
Chris Dixon, co-founder of Hunch.com and a personal investor in early-stage tech companies such as Skype, TrialPay and others, offered an enlightening take on VC ethics in a column for businessinsider.com. Namely, is it okay for a VC to back out of a term sheet?
A term sheet kicks off the negotiations between a venture capital firm and potential portfolio company. It summarizes the terms that the proposer (issuer or investor) is prepared to accept. It’s similar to a letter of intent, a nonbinding outline of the principle points which formal legal documents will cover in detail, according to the website, vcexperts.com
Although it’s not legally binding, a VC with integrity rarely backs out of a term sheet, Dixon says, unless they discover something truly awful, such as criminal fraud. As a further example, he mentions that Sequoia Capital, the highly successful Menlo Park, CA-based VC firm whose companies account for an astonishing 10 percent of NASDAQ’s market cap, has only backed out on one term sheet in the past 10 years.
Less scrupulous firms, however, may give a company a quick, high-valuation term sheet just to prevent the company from talking to other investors while they then perform in-depth due diligence. When they find something they don’t like, they use it to beat the price down or simply walk away from the deal. This can leave the impression in the marketplace that the company is “damaged goods,” Dixon says. This whole approach gives investors an unfair advantage in the negotiating process.
But taking the more ethical approach and sticking to a legitimate term sheet pays off. The early-stage community, particularly the tech community, is very small and your reputation matters. “Word travels fast when firms trick entrepreneurs. It will come back to haunt you and your firm,” Dixon says.
