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Private equity has grown significantly since its inception in 1946, with explosive exponential growth as the industry continues to produce outsized returns. The boom in growth didn’t truly accelerate until the LBO craze of the 1980s drove wild amounts of attention toward the industry. From 1980 to 2022, PE saw the number of funds increase from 24 to a staggering 19,000. 

Assets in the space also ballooned from under $600 Billion in 2000 to over $7.5 Trillion by 2022. And lastly, the number of employees working in PE increased from under 50k in 2013 to almost 90k in 2023. While this relentless growth has created significant opportunities for the industry, it hasn’t come without its challenges. 

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Growing Human Resources Needs

Throughout the industry, firms have faced challenges managing their internal teams. Many firms will acknowledge that there has been so much growth and so much opportunity by way of dealmaking, that the administrative and operations functions often have trouble keeping up. This has led to administrative employees needing to embrace technology, tools, and processes to allow their firms to scale with the growth. The tipping point to embracing technology is clearly happening right now.

CFOs and Human Resource leads specifically deal with a number of challenges related to managing internal functions within their firms. Not only are they responsible for maintaining key metrics for limited partners and portfolio companies, they’re also on the front lines handling employee compensation matters.

Given the focus in recent years on talent recruitment, and more importantly retention, providing fair and transparent compensation has become a key concern  industry-wide. A key aspect of this is the biggest factor in investment professional compensation: carried interest.  Ask any CFO or head of HR what they get asked about the most frequently from employees and they’ll respond: “participant carry”.  

To put the magnitude of carry into perspective, according to Heidrick & Struggles, a Principal at a PE fund with $1B-$2B of assets under management earned an average of $550,000 across salary and bonus in 2023. Meanwhile, carried interest for a Principal in 2023 at a fund with $1B-$2B of assets averaged between $5.4M-$6.3M. In short, carried interest reporting is incredibly important for both the fund to report to its employees, and for the employees to understand. But the structuring of different carry plans has made monitoring carry in Excel a cumbersome and time-consuming process. 

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Why Has Carried Interest Gotten So Complicated? 

Until recently, top performers were comfortable staying with their firm for the majority of their career. Because of this, carried interest plans were relatively straightforward with standard vesting schemes, top-down approaches to allocating carry and few unvested points to contend with. In recent years, however, employee shuffling has become more common as top performers get recruited away or leave to start their own firms. To remain competitive, firms have also started offering more creative comp plans, with manipulating different levers including GP commit & leverage, unique vesting schedules, phantom carry and performance incentives. 

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GP Commit and Leverage

GP commit, and offering leverage to more employees as part of their GP commit, has become more and more commonplace. By implementing the use of leverage, sometimes through even more complicated processes like management fee waivers, employees are able to borrow the entire amount of capital they need to “pay-in” in order to receive a carry allocation. While a valuable tool for employees, this is also very difficult for a firm to track. Because the loan that the employee received to fund their GP commit needs to be reimbursed, all distributions from carry and the investment will need to be used in order to pay off the loan and any interest accrued. Things can get even more complicated in cases with variable rate loans, when it becomes harder to track the employee’s loan balance.

Multiple Vesting Schedules

Vesting schedules also play into the complications of maintaining a carry plan. While the typical time-based vesting schedule is alive and well,  we’ve also started seeing fund managers embrace more flexible schedules, including deal level, vintage carry, and performance based vesting. Different schedules can be implemented at the individual employee level, with different incentives designed specifically for accomplishing certain tasks related to a deal or a fund. With multiple variables to track and monitor, it can lead to a cumbersome process with the potential for human error if handled solely in excel.

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Influx of Joiners and Leavers

Unique vesting schedules are also a factor that have to be considered when managing joiners and leavers for a firm. If an employee has negotiated a vesting schedule that has specific milestones and decides to leave the firm before the fund has been liquidated, it can lead to a lot of work for the company to accurately reflect which of those milestones has been achieved.On the other hand, when people join a firm with a fund is already in-flight, complications can arise when assigning points to new hires and tracking appropriately. 

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Tax Implications

With anything in finance comes the burden of accurately recording and reporting different taxable events. With a growing employee base with regular and estimated taxes to pay, K1 distributions and transactional activity reporting is another function driving overhead across the finance team. 

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Document Management 

As fund managers launch additional vehicles and expand carry plans to more participants, building, managing and chasing signatures on associated legal documentation become cumbersome. In certain cases, employees will also need to complete LPAs related to their GP commitment in order to receive carry. Most firms handle documentation in different, yet outdated ways. Some firms choose to hand fill the information specific to each individual, some use mail-merge to pull information from Excel spreadsheets, and others simply outsource the document process to their counsel or external law firm. 

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How Software Can Help

In the top of this post, we mentioned the need to embrace technology, tools, and processes in order to effectively scale a private equity firm. Since carry has implications across all aspects of a firm, streamlining carry and employee compensation has been front of mind for CFOs and HR leaders throughout the industry. 

By transitioning different components of Excel to software, firms can keep their administrative headcount low and allow individuals in those functions to focus on higher-priority projects. Software also drastically decreases the probability of human error, especially when employees are tasked with managing multiple initiatives at a time. 

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Industry Dedicated Software

At Navable, we’ve heard the challenges from numerous departments when it comes to compensation, carry, and GP commit. Whether you’re a CFO trying to scale your systems out of Excel so you can focus on other projects, the Head of HR looking  for a better way to manage total comp, or a member of the Investment Team looking for better reporting across vehicles, funds and deals; Navable’s configurable software is built to streamline inefficiencies across all aspects of the firm. 

Finance Teams are in need of software to make their lives easier. Instead of creating time-consuming reports for GP participants that aggregates their carry and commit metrics, Navable’s software applies accurate data to each participant’s account automatically. Vesting schedules can be created and tracked within the platform.. GP commit and leverage can also be tracked, giving CFOs and their teams the ability to monitor and report on additional value-add metrics.

HR and Administrative Teams can simplify their annual and quarterly compensation reviews by giving employees a customized total compensation dashboard that acts as a unified place for displaying payroll, benefits, carry awards and any other types of compensation.Tax documents, transaction notices and subscription agreements can all be stored and signed (if need be) via the platform, reducing questions around documents and the need to chase for signatures.

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Conclusion

Improving back-office operations with the use of technology is top priority for any growing firm as it looks to reduce as much operational burden and expense as possible. Navable’s software, built by FinTech veterans specifically for alternative asset managers, enables multiple teams across an organization to operate more efficiently.