How Often does this happen in the industry?
We all hear about the perks and epitome of private equity is when you start getting carry in the fund, whether you are a senior associate, vp, or a mid-level hire and starting to share some upside in the job. While everyone focuses on the upside that it's going to be $mm over the next couple of years and getting rich on paper at least, I am wondering how often does carry not materialize for folks that are in the industry or the carry $ are so minimal that it becomes going to PE seems like it was a wrong decision. We won't talk about founders or partners here given the audience here on this forum, but for monkeys that have been in the industry for awhile - have you experienced or heard of this before?
I am in a situation where we have an european waterfall and we don't get anything until end of fund life, and there had been a couple bad investments that we might become duds and have an impact on fund's performance. If all goes well, LP still gets their money but it would likely be something very miniscule when it gets paid out for us....
I just find that we hear about the prospects of making it rain and getting 7 figures a lot assuming 2x on the fund, etc, etc. but the dark, gloomy perspective of never making it there does not get much attention here. Maybe I'm just the gloom and doom phase.... happy to hear other perspectives.
Happens more often than you think - and often at the funds you would have heard of. Go look on Pitchbook - there are many funds that below, at, or barely above the typical 8% pref for LPs in which case the entire fund does not pay out carry and basically the investment professionals worked for salary + cash bonus (which is usually pretty high) but also not life-changing - and comes at the cost of WLB.
Would also add that carry takes so, so, long to get paid out sometimes that it almost feels illusory. The days of big and reliable carry, IMO, are over - 80% of the 'fast' carry dollars are going to a small minority of the GPs that deploy capital quick and have massive wins (over the past ~3-5 years those are the usual players in Tech or HC).
^Yeah happens all the time. If you have access to Preqin or some other fund database, you can basically just screen for funds that are nearing end of life with net IRR less than cost of capital... there will be hundreds (maybe thousands, depending on what timeframe we're talking). Edit: didn't realize poster above me said basically the same thing but with PB - probably more accessible for most people.
When analysts leave for PE with pie in the sky comp ideas, this is one thing that often gets glossed over - first you have to actually earn that carry (and you are competing against a bunch of roughly equally smart/accomplished people), and there's also this big cash outlay overhanging everything too since you have to be in the fund. You're super levered to the performance of your fund, which can be great, but also it can be not so great too.
It can happen, but through vintages it should generally even out. What matters more is the timing of the fund that crushes it vs fund that sucks wind. If you work at a fund across 3 fund vintages and there’s a bad, great and ok fund. You ideally would want the bad first, the ok second, and the good last… to line up with your largest carry allocation when you’re most tenured. You’re basically getting paid tens of millions of dollars in cash comp (ax your career) to sit around and wait to find out how much your carry will be worth. So I don’t really see how you ever paint a picture of “having made the wrong decision”. If you’re carry is out of the money in every single fund, it’s because you picked a bad group of investors to partner with professionally… so you deserve it…. In the meantime, you did get paid a premium to IB for more interesting work.
This is the attractive point about secondaries funds, very few do not get into the carry. So, whilst the carry pot is slightly smaller, the likelihood of getting a piece of it is significantly higher and the risk of not getting at least your coinvest back (ie TVPI
Carry is typically not realized until year 7 or 8, if it is at all. Because of the way the IRR formula works, early exits do a lot to underwrite carry.
As mentioned above, I think few people look at the probability of carry or variability of carry and instead focus on what the $ is if carry is realized.
The partners always have an incentive to talk about the very high likelihood that a fund will go into carry so run your own model.
#1- the “if at all” qualifier is dumb. Almost all funds are in the money on their carry.
#2- I don’t know anyone who assumes they’ll make full freight returns when valuing their carry dollars at work. Most people take a pretty conservative haircut to historical returns for the fund/strategy. Anyone who values their carry based on the target returns (other than fine folks who work at Veritas) in the offering memorandum is stupid.
Looks at vintage year median performance by Cambridge Associates/Pitchbook/Preqin. Yes, there is survivorship bias, etc etc, but the reality is that PE funds have outperformed for a very long time and have had no challenge hitting the 8% pref. Even with pricing/market cycle, the reality is that even many 04-07 vintage, which were hardest hit by the crisis, are in the carry. The 04-07 vintages have median net IRRs of 9.7 to 12.2%. Further, if we go back to 2008, the BOTTOM quartile of the US Buyout benchmark has never fallen below 9.4%.
There is more to the story here (different carry structures, simple vs compounded pref etc), but private equity has outperformed and will likely continue to outperform as an asset class. If we assume the long term return on equities is 8%, consider that private equity is often investing in asset light/faster growing businesses and can more aggressively use leverage... as an LP, I generally think of PE as a 10-12% LT real return from here for asset allocation modelling purposes.
I understand that carry represents a bulk of PE comp, but why is there a sentiment that cash comp is trash. From what I’ve heard, PE partners still make 7 figures in base + bonus with significant upside from carry. That seems like a pretty attractive role even if in the unlikelihood chance that you get 0. Isn’t that pretty attractive downside protection?
$1mm a year in cash - after tax is $500-600. In VHCOL areas with inflated housing/education costs you are saving maybe at best $200-300k a year. Do that for 10 years that’s maybe $2-3mm. Math is too simple but you get the idea. Good money. But was that worth 10 years of grinding? That’s what it is w/o the carry
If I’m making 500k as a senior associate, I promise you a partner is making a lot more than $1m cash.
Not only depends on the fund's performance, but also on the partners'/LPs' willingness to actually concede the economics when the time comes in years 7+ (when you've already sank those 7+ years into making them money).
Fairly common, and you will see junior partners on down bail on non-performing funds for this reason. It is a very real possibility as it only takes one or two poor investments to wipe out the carry. Also makes the prospect of raising another fund all the more difficult depending on the vintage.
Related question here - can anyone more senior shed some light on the mechanics for the hurdle rate for carry to be paid out?
Understand typical is a 8% hurdle, so does that imply that in year 7 the fund has to hit 1.7x MOIC (1.08^7) before any carry gets paid? How does timing of capital drawn come into play?
Looking at pension data, there're not many funds that even hit that 1.7x MOIC...
First off it’s 5 year not 7… so it’s ~1.5x.
Second, it varies from firm to firm. Some wait until the fund returns are fully baked to pay out carry so that there’s no an awkward clawback if a late investment or 2 shit the bed. Others funds don’t wait for the very end and will pay it out as the fund get somewhat mature.
Hey, not sure I understand the distinction between 5 and 7 years. What do you mean when you state year 5?
Thanks, saw your post on the weighted average duration typically being 5 years so that makes sense.
Was using year 7 as I understand most funds only start paying out carry on the 7/8th year after final close, but wasn't taking into consideration that deployment happens over a ~3 year timeframe.
So simply put, the first time anyone gets a sniff of carry dollars will quite awhile after they make VP... (assuming that's when they get carry dollars).
Depends on the language in the docs. Generally it is an 8% IRR so I'd agree with your first example. Also, a lot of they money is made on the catch-up. So LPs get their 8% IRR, GP gets its catch-up then it goes 80/20.
The weighted average duration of a PE fund isn’t 7 years. It’s 5 years. So your 1.08^7 should be 1.08^5 which gets to like 1.47x MOIC or something like that.
thank u
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