Private equity carried interest payouts
Under the fund-as-a-whole distribution model (European waterfall) where the first exit provides enough liquidity to pay the capital return, preferred return ("hurdle rate") and catch up and start paying carried interest (20% of the remaining proceeds), is it common practice for investment advisors to pay out carry at 100% vesting to carry holders still working for the investment advisor even where they are not 100% vested?
I ask with the following case in mind: despite being around 50% vested according to the vesting schedule, a carry holding friend of mine who works for an investment advisor has received 100% vested payouts for the first exit, despite the carry agreement stating that carry holders should receive their vested carry when payouts are due.
This raises the question of whether accelerated vesting has been triggered, the condition for which is defined in the carry agreement, which roughly translates to "the closing or winding up of the fund". As the fund still has two companies to exit, it it is not being "closed" or "wound up" in the narrow sense of those terms (unless the first exit could be deemed to trigger the beginning of the wind up phase).
However, the investment advisor's management has acknowledge that accelerated vesting was in application for the first exit. Limiting it to the first exit makes little conceptutal sense, however: the vesting clause applies at the fund level, not at the deal level.
Given that there seems to be no other way in which vesting could be deemed to be 100% other than through the investment advisor's management's discretion - which wouldn't make all that much sense as it would be giving away liquidity voluntarily and disincentivising it's people to stay on - is this a case of de facto accelerated vesting (regardless of the condition in the carry agreement)?
Bump curious as well.
On top of that, I was wondering; how do the portco rollover equity owners/mgmt get paid in these models? Do these people usually also have to wait until the fund exits these other 2 investments to receive their equity & returns back?
What if 1 or 2 of those other investments in the fund take a really long time to sell? Is there a way to protect against that risk?
I believe most U.S. PE firms have distribution models done on a deal-by-deal basis
That was my understanding of distribution models as well
Correct.
Are you asking about literal portco managers like CEOs etc.? They have a separate incentive plan not tied to carry but to sweet equity and it’s solely based on their own company’s performance. They will invest into a new deal once exited
No my question was separate from OPs question on investment professionals’ carry at the PE firm.
My Q was related to owners of portcos in funds that use the fund-as-a-whole distribution models: if a fund buys xyz company, and founder / mgmt team of that portco rolls a portion of equity, how are those people affected if the fund sells that portco before the other portcos in that fund?
Or what if one or two of the other portcos in that fund don’t perform well and/or take really long to sell? Would xyz company’s founders’ equity be stuck in that fund and diluted from losses made by other portcos? Can they even get their money back or would they need to wait until every fund portco is sold under the fund-as-a-whole distribution model?
Seconding this question. Why would the portco have to wait for returns on the entire fund? Thought they appropriately cash in their shares at each individual protco’s exit event.
Nvm. Asked and answered already above. My understanding is correct. 🙏🏼
OP, would you also mind providing a simple hypothetical example of what you're describing as to what an exit and payments would look like? I also wanted to learn how this works as I haven't seen this from my projects.
Also, second the questions that the person above asked
Lol is that the way it’s done in European funds?
Hm interesting... didn't know that either
Generally speaking, vesting is relevant for when you leave and provided you meet good leaver provisions. While you are still there and in the happy situation that carry is paid earlier than expected you are paid your full allocation (irrespective of vesting).
Thanks Franco. So you are saying that full payouts are common, but vesting only kicks in when people leave as good leavers and then they lose anything not vested for future payouts (i.e., their penalty for leaving).
How does that make sense though? The investment advisor is paying sitting employees more than they have vested, which limits their liquidity and loosened the golden handcuffs on employees, whose incentive to stay on and "finish the job" goes down. If they only received vested carry even while employed, they would be hungrier to stay until the moment that full vesting is triggered. As mentioned, only vested carry is due on payouts according to the vesting claus in the Carry Agreement, and there is no reference to full payout for holders while employed by the investment advisor or not.
Yes, that is how it works in my experience. Usually vesting occurs over a 5-7 year period which happens to line up with when funds typically go into carry.
You could look at it the other way, a fund that is able to pay carry earlier than expected is generating real wins and presumably team are involved in delivering that. The retention tool here becomes more carry payouts (as this fund is now in carry) and the potential to do it again next fund.
You can always seek advice from an employment lawyer for your jurisdiction.
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