Confused about carry at PE Fund

So in general I understand some about PE salaries, but I have a few questions. So let's hypothetically say you're a VP with a salary that includes 0.5% carry, which in a given year (Year 1) amounts to $500,000 for you, which is spread out over a period of 5 years at $100,000.

So Year 1: Base + Bonus + Carry ($100,000)
Year 2: Base + Bonus + Carry ($100,000)
Year 3: Base + Bonus + Carry ($100,000)
Year 4: Base + Bonus + Carry ($100,000)
Year 5: Base + Bonus + Carry ($100,000)

But, this carry was generated after selling just one investment, right? So let's say next year (Year 2), you again have a salary with 0.5% carry, but this time that amounts to $1,000,000 for you in carry compensation because your PE company sold a larger investment, and this is paid at $200,000 over 5 years. So then would your salary look like this?

Year 1: Base + Bonus + Carry (Y1's $100,000)
Year 2: Base + Bonus + Carry (Y1's $100,000 + Y2's $200,000)
Year 3: Base + Bonus + Carry (Y1's$100,000 + Y2's $200,000)
Year 4: Base + Bonus + Carry (Y1's$100,000 + Y2's $200,000)
Year 5: Base + Bonus + Carry (Y1's$100,000+ Y2's $200,000)
Year 6: Base + Bonus + Carry (Y2's $200,000)

Basically, my question is how many times does a PE fund exit an investment and thus give you an opportunity to make carry in a given year. I understand you may not make money on every investment you sell, and that this may vary based on the size of the fund, but can someone give a general idea, maybe how much a megafund sells and how much a 500 mil fund sells.

I can't post links but there's a report named private equity compensation TRENDS IN NORTH AMERICA: 2016 by Heidrick and Struggles, would you say this report provides a good estimate of how much you make in carry money from all the sold investments of your PE firm in a year?

Thank you!

Comments (18)

Aug 31, 2017

Pretty open ended question, but I'll take a stab. Typical holding period for a buyout investment is 4-5 years. You also have to take into account that carry is done on a fund-level basis. While a specific investment may in theory return carry, what matters at the end of the day is what the fund has done, so carry will be back-loaded, otherwise you end up with clawback issues.

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Sep 1, 2017

Agree with m8's comments, but the major issue with your table above is that while the carry will likely get paid out over 5 years, it will most likely not be a similar amount every year like base and bonus (can be very lumpy depending on size and return on investments sold that year) and will not begin to pay out for 3+ years from the time you start "earning" it. As m8 mentioned, unless you work for a fundless sponsor that raises capital on a deal-by-deal basis (i.e. not a traditional PE fund), carry is usually only paid out once you have returned invested capital and covered a hurdle rate (usually 8% annually) on the invested amount for the whole fund, and not on a deal-by-deal basis. There are some cases where partial carry payments are made in the interim if the portfolio is healthy and a good portion of capital has been returned, but PE professionals try to avoid a clawback situation where they have to return compensation after it was paid because investments they thought would pay off don't. In short, be prepared to wait longer and have less consistent payouts than your model above. Also be prepared to look a lot wealthier on paper than your actual bank account through the early innings of your PE career, because serious carry payments can take 5-7 years because they are back-end loaded.

Regarding the H&S report (and other PE comp reports), carry is usually reported on a per fund (not annual) or percentage of carry pool basis. So if you earn carry in a fund and H&S said that should be $500K, you are earning $500K over the entire life of that fund, likely split up over 3-7 years. As you mentioned, way too much goes into this to make meaningful annual comparisons like base/bonus - size of fund, how quickly it's invested, returns, when companies are exited, etc.. You can also be earning carry on more than one fund at a time if you have been with the firm for a long time. Rather than target a specific $ payout for the fund or annual $ amount, most negotiation is done around the % of the carry pool (50bps, 150bps, 500bps, etc) since that's the easiest thing to control for.

Finally, the best way to think about carry is a simple math equation like this - multiply the size of the fund by 20% for the total carry pool. This assumes a 2x ROIC on a fund (some will be much higher, some will be lower). If you make 2x on a $500MM fund, you will return $500MM of capital cost (1x) and $500MM of profit (1x). In a traditional 20% carry model, the firm gets to keep 20% of the profits or $100MM. If you received 0.50% (50bps) of carry, you would receive $500K over the life of that fund. You can do the same math on larger funds. Much more money to play with, but generally lower returns and a lot more mouths to feed.

Hope this helps.

Sep 1, 2017

That was super helpful, thank you!

Best Response
Sep 1, 2017

No problem - happy to help. To illustrate how I would think about your table above, see the example below of someone who starts as a Vice President and then gets promoted to Principal and then Director after three years at each title (obviously timeframe for promotion and actual titles will vary by firm):

  • VP1 - Base + bonus; accruing carry at 50bps in Fund I
  • VP2 - Modest increase in base + bonus; accruing carry at 50bps in Fund I
  • VP3 - Modest increase in base + bonus; accruing carry at 50bps in Fund I
  • Pr1 - Promotion; big increase base + bonus; Fund I starts paying carry ($75K); still accruing carry at 50bps in Fund I and offered 125bps in soon-to-be-raised Fund II
  • Pr2 - Modest increase base + bonus; Fund I pays carry again ($175K); Fund I now fully invested (no new carry accrued) and 125bps accrued in Fund II
  • Pr3 - Modest increase base + bonus; Fund I pays carry again ($225K); still accruing 125bps in Fund II
  • Dir1 - Promotion; big increase base + bonus; Fund I still fully invested (no new carry accrued); carry increased to 175bps in Fund II; no exits from Fund I or Fund II; no carry paid from either fund
  • Dir2 - Modest increase base + bonus; Fund I exits last investment (small exit for $25K carry for $500K total paid from Fund I); still accruing at 175bps in Fund II; no exits or carry from Fund II
  • Dir3 - Modest increase base + bonus; Fund II starts paying carry and has several significant exits ($600K carry from Fund II); still accruing at 175bps in Fund II; raise Fund III and start accruing at 250bps in Fund III

The point of this exercise is to show you that - (i) it takes a while to really start earning big carry payouts, but once they start hitting, they are very meaningful especially if you are earning carry on multiple funds; (ii) the level you are "earning at" (getting cash payments) will lag what you are "accruing at" for the new investments you are making that year; and (iii) the exercise of comparing annual carry payments in a comp study is pretty futile - it's just really unpredictable in the real world. Depending on the firm, your carry % allocations can also change throughout a fund and be averaged over the life of the fund. Some firms keep the carry the same throughout the life of the fund. Your dollar payouts will also vary drastically by year.

Lastly - based on my basic calculation above, you've probably noticed that AUM/fund size has a major impact on the carry pool. A $5B fund will probably (and should) generate much more carry dollars than a $500MM fund. That said, I would caution you from ruling out smaller funds outright for a few reasons: 1) It is significantly harder to be granted meaningful carry (% wise) at larger funds. There are simply far more mouths to feed and a hierarchy that has to be maintained. Some individuals will work a decade plus to get a few percentage points of carry at larger funds. This will still result in very significant cash payouts, but I know associates at smaller funds who were able to get several full percentage points of carry during their first few years at the firm; this would likely be unheard of at a larger firm. 2) It is also extremely competitive at the MF level, which is bad news when you feel a constant pressure to perform and have the high potential to burn out. It is still very competitive at smaller firms, but there are less people vying for a similar number of promotion opportunities. Making partner at a MF is no easy feat. 3) Most funds have a vesting schedule for carry (similar to 401ks) where you forfeit some or all of your carry if you voluntarily quit before a certain period of time at the firm. Bad news if you get burned out and realize that carry may never reach you. 4) While plenty of MFs generate strong returns, research shows that smaller firms have a higher likelihood of hitting much better ROICs. They are definitely higher beta, but the likelihood of hitting a 3x/4x+ fund is much higher at a smaller firm. Rerun the calcs above and you will see how much of a difference this makes. You can make up a lot of AUM deficiency with better returns (if your firm generates consistently solid returns). 5) If you look around the industry you will see a slew of firms founded by partners of larger firms. Carry will always be concentrated at the top and at some point partners will realize they can do far better on their own if the founders/lead partners are stingy with carry. Getting a huge portion of a much smaller pool of assets can often be much more attractive (but have higher risk) than earning a sliver of carry at a large fund and continuing to make your bosses much richer. To be clear, MFs are incredible firms to work for, but just want to highlight the other side of the coin.

Sep 6, 2017

+SB'd on both of those responses. Excellent info man, thanks.

Sep 8, 2017

Great example. When you leave do you essentially forfeit your carry, even the accrued on deals you worked on? I'd imagine so but just checking. Also, if you join mid way through the funds cycle how is your carry, is just on new deals?

Sep 8, 2017

As APAE pointed out below, some firms will split carry into two bands - a global pool and individual deals. That said, my personal experience has been that there is only a global pool, but carry percentages will be increased/decreased every year throughout the life of the fund according to individual efforts/accomplishments that year. So in effect you get to the same place - if you bring in a bunch of good deals, you get compensated for it with more carry. In this case, however, there is no distinction between the deals you worked on and the deals you didn't - it is still a global carry pool that encompasses every deal done in that fund. True deal-by-deal "economics" are really only feasible outside a traditional PE fund structure - i.e. fundless sponsors who raise capital from different parties for each deal or a family office that may give their deal professionals single-deal-level economics since there is no "fund".

In the global structure I highlighted above, if you show up in year five of a five year fund and get 100bps carry, you would be averaged over the life of the five years (0%+0%+0%+0%+1%)/5 to get you 0.2% or 20bps for the entire fund. So you don't get the full 100bps economics for that fund, but you still get some benefit from deals done long before you joined (as long as they were done in that fund). In this case, you'd likely get lower $ carry payouts (only 20bps) for that fund, but could end up being "in the carry" and receiving payments within only a year or two. If you joined at the beginning and got 100bps each year, you would obviously be at 1% carry for the fund and would get more carry $ for that fund, but likely have to wait longer for it.

Regarding vesting, would love to hear thoughts from others, but from what I've seen this is generally done on a five year basis to mirror the expected life of the fund. The two most common structures I've seen are equal weight every year (20%/20%/20%/20%/20%) or something back-end loaded like (0%/0%/30%/30%/40%). In the first case, if you quit after one year, you would get to keep 20% of the carry you were earning (i.e. if you were at 100bps, you would walk away with 20bps) and the carry you forfeit would be distributed pro rata to those remaining in the pool. In the second case, you would walk away with nothing. Obviously this will also depend on if there is a "blending/averaging" concept like I mentioned above because you would also be at 0% for years 2-5 if you are not at the firm, so your carry percentage would really end up at a de minimis amount. Most investment professionals get protections so that if they are terminated without cause or there is a change in control at the firm, they fully vest. That way they can't get forced by their firm or an acquiror into taking a lower payout. If they are terminated for cause (usually only unethical practices, not poor performance) they can forfeit their carry altogether.

To be clear, there is no "right answer" for this stuff, but this has been my experience. You could poll five PE professionals and likely get five different structures, but a lot of the overall concepts above will be the same. See the article below for some more detailed info:

Sep 8, 2017

Much appreciated detailed response

Sep 6, 2017

I gave you +1 for each of your posts @AmoryBlaine. You nailed this, great illustrations.

The only addition I'd make to the very insightful and accurate comments on the megafund versus smaller fund decision is the consideration of the type of people you work with (regardless of the fund size or cap range you play in).

One important part of compensation at the level penultimate to 'partner' (some firms call it 'principal', others 'director') can be variable based on sourcing. Some firms split carry into two bands: global carry on the fund plus individual carry on deals you source (the classic 'eat what you kill model').

When you're in that principal or partner-level role, your ability to get a deal through all the hoops and into the portfolio is a function of (a) the merits of the deal, (b) your ability to articulate a compelling investment thesis, and (c) who is on I.C. If you're at a place whose culture comes with any meaningful degree of internal politics, your life is much more stressful than people acknowledge.

Some of the smaller places or more intimate shops have a unanimous policy. If you offered substantive questions on Bob's pet deal two months ago that everyone could see had some real tumors to it, you might have the greatest deal in the world (non-banked, throwing off cash like DJ Khaled at King of Diamonds on a summer Friday night, and an easy exit to a strategic acquirer lined up), but if Bob took that as a personal affront, good luck getting your deal of the decade through I.C.

In short, remember that an additional element of your calculus has to be who you're working with, not just the mechanics of how you're getting paid.

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Sep 6, 2017

Great point, @APAE. Definitely agree with this.

Sep 8, 2017

Great points by both of you here.

"Who am I? I'm the guy that does his job. You must be the other guy."

Sep 7, 2017

We have a Bob. Bob is an asshole.

Sep 8, 2017

Semi related but is it true that finance professionals (finance as in FP&A, treasury, etc.) within a fund also get carry? Recently had discussions with FD who said he and his subordinates are getting carry. Pretty awesome.

Sep 8, 2017

I haven't heard of this before. Very unusual from what I have seen. If they get anything, their carry will be minimal.

Sep 8, 2017

double post - delete please

Sep 8, 2017

triple post - delete please

Sep 8, 2017

I have seen this, but as kinghongkong mentioned, it's unusual. At the end of the day, carry is just a powerful long-term incentive plan used to motivate and compensate employees. So some firms will use it to compensate operating partners and/or their finance function if they want to see them stick around. That said, I've only seen it for top level finance function professionals (CFO/fund controller, etc.). But as kinghongkong also mentioned, revenue generating (i.e. deal professionals) will likely always get the lion's share. A finance professional getting 0.1% carry, a junior deal professional getting 1.0% and a senior partner pulling in 10.0% or more are all "getting carry", but what that means $ wise is obviously a lot different.

Sep 8, 2017

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