How do carry dollars at work translate into annual compensation?
I'm looking at the Heidrick and Struggles 2019 PE compensation report. The carry dollars at work definition (directly from the report) is as follows:
Carried interest is calculated using “carry dollars at work”—the expected return on total carry participation across all vehicles, based on achieving a net 2x return (above hurdle and after fees) in a vehicle charging a 20% performance fee. For example, 7 points (700 bps) of carry (out of a possible 100) in a $500 million fund with 20% carry would result in $7 million of carry dollars at work (500 X 0.2 X 0.07 = 7).
Using mean compensation for partner/MD's at a firm with 40bn or more AUM as an example, the report gives $1.2MM as total base + bonus compensation and $51MM for carry (all funds).
The cash + comp data was given for 3 different years (2017, 2018, 2019), but the carry (all funds) was simply given in a table. How would the $51MM carry dollars at work for all funds factor into annual compensation? Is more information needed to answer that question?
Trying to translate "Carry Dollars at Work" into an annual compensation level is an impossible task. The primary reason is that carry is allocated on a fund basis and the lifecycle can be variable. Here is the way that I think about it:
Carry is allocated on a per fund basis. Every time a new fund is raised, those who are participating in the carry will receive their carry grant which will be more or less fixed through the life of the fund. Using the industry standard parameters of a 2.0x return and 20% carry fees, you can pretty easily calculate the expected carry payout over the life of the fund. Nothing controversial here.
The difficulty arises because new funds can be raised every 3-5 years while a typical fund lifespan is about 10 years. This means that almost all senior professionals have carry dollars at work from multiple funds simultaneously. Due to this overlap and the variability in timing between fundraises, there is no way to come up with a definitive annual number. As a proxy, I like to calculate the expected carry payout and divide by the number of years before the next fund is raised.
Here is an example. You have a $500mm fund and 5% of the carry. A 2.0x return suggests $500mm of profit to the LPs, $100mm aka 20% of which goes to the carry pool. You get 5% of the $100mm so your expected carry payout over the life of the entire fund is $5mm. The next fund is not going to be raised for another five years so you divide the $5mm by five years and your annual carry value is about $1mm.
Fast forward to five years later... the fund raises a $750mm fund and you get a new grant of 4% of the carry. Doing the math again, $750mm of expected profit at 2.0x which equates to a $150mm carry pool. Your 4% is therefore worth an expected $6mm. Divide that by five years and your annual expected value is about $1.2mm. Congrats, you just got a fictitious $200k raise!
This method isn't perfect and obviously doesn't take into consideration vesting, but I like it because it factors in the velocity of fundraising which is a key factor in generating carry. Put differently: If you have 50% less carry dollars at work per fund than your friend but your firm raises a new fund every two years and his every five, you're going to earn 25% more than your friend in carry, all else equal!
Hope this was clear. Note that I have no idea how H&S calculates it in their annual PE compensation report.