Carried interest is a share of profits from a private equity or venture capital firm, paid as incentive compensation to the fund’s general partner. While it is typically only paid if a fund achieves a specified minimum return, Richard Change, CEO of PFA Solutions, explains that they are becoming increasingly risky in their current form.
If you listen closely to CFOs at private capital firms, they will shed light on the challenges they face today when managing complex compensation and carry plans. These challenges are being made worse by uncertainties in fundraising, staffing and making sure rewards and performance are aligned.
They will say that managing multiple funds, recalculating awards for leavers and joiners, employee and partner reporting, and overseeing various vesting arrangements have complicated their plans beyond what spreadsheets can handle. They will emphasise the need for innovative solutions to make these processes easier, more dependable, more accurate, and more flexible.
Many CFOs facing these challenges are now exploring software-as-a-service, or SaaS, technologies to transcend their problems and digitise their compensation and carry plan operations. They’ve discovered that their legacy processes are not sustainable long term as they grow their businesses. Most importantly, they’ve seen how managing compensation more accurately and efficiently exerts a positive impact on operations, internal employee experience, and retention – earning them significant standing in their firms.
The growing complexity of private capital deferred compensation and the many options have compelled private capital firms to invest significant time and resources in managing these plans. CFOs need to carefully choose a partner whose solution will adapt to the firm’s plans today and offer new features and analytics that add value.
Option overload
Carry and compensation has never been more intricate or evolving faster than today. Some firms grant carry at the fund level. Some allocate awards on a deal-by-deal basis or down to the investment-tranche level. Many firms create additional discretionary plans as part of their carry program in the form of phantom and jump ball arrangements to further reward various employees. Some change their terms over time. Many firms rethink and change how they structure vesting schedules and other plan terms as they grow and evolve.
On the co-investment side, firms may provide loan programs and repurpose management fees (i.e., management fee waivers) to aid in the mandatory fundings required by GP members. As the talent market changes and firms employ new participants into funds that have value, firms use hurdles and catchup provisions for these new joiners, too. These nuances accumulate over time, they can overload accounting and administrative staff. Successful firms continue to add new funds and strategies as they grow and expand. The intricacies of their plans multiply accordingly, leading to challenges in maintaining efficiencies, reporting needed, accuracy and controls.
Spreadsheets initially offer private capital CFOs convenience and flexibility, but they can become cumbersome and prone to errors, especially human errors, and when exceptions to rules arise. To be sure, spreadsheets are essential and won’t be going away anytime soon. Firms that rely on Excel for long-term management of compensation and carry plans, however, will be facing headaches when they try to scale them.
By transitioning from spreadsheets to dedicated software, on the other hand, private capital firms can streamline their compensation and carry plan calculations, enhance accuracy, deploy better participant reporting, and improve efficiency. Software solutions also provide a database structure that will make myriad operational impacts, allowing, for example, more transparency and easy access to historical data and enabling reliable reporting at any point in time – unlike searching one’s email account for the latest version of a table on Excel.
Private capital firms face significant challenges when it comes to calculating complex compensation and carry plans. CFOs are looking for scalable solutions to overcome these challenges. By leveraging SaaS technology, private capital firms can simplify the process, enhance efficiency, and set the stage for improved operations. Firms that explore these innovative solutions today will ultimately achieve the best outcomes.
Richard Change is the founder and CEO at PFA Solutions. PFA Solutions is a software provider dedicated to the alternative investment industry.
