Episode 6 of The Private Capital Talent Series below features Kyle Burrell of EY on carried interest as a unique lever for talent retention!
Chris Gale 00:02
Welcome to episode six of PFA Solutions’ Private Capital Talent Series. We’ve invited, from EY, the fantastic Kyle Burrell, and PFA’s Ryan Burger is also joining us to talk about private equity trends. We’ll focus on carried interest as a unique talent retention lever. For those coming on with us today, you’ll see that you can enter questions We look forward to any you might have.
Kyle, can you tell us about yourself?
Kyle Burrell 00:58
I’m an audit partner at Ernst and Young based out of our Boston office. Typically, I work in asset management, mostly private equity and venture capital. But I serve mutual funds and some of the gifts-investment performance reporting solutions we have, as well. I’m also the author of our EY Global Private Equity Survey, which is going on its tenth year. And when I’m not issuing audit opinions and working on audits or the survey, I have three kids under the age of three. That keeps me very busy. So never a dull moment over here.
Chris Gale 01:44
Fantastic. On the survey, can you tell us about that? Especially the 2022 Global Private Equity Survey? That’s the data I think we want to drill into especially. You mentioned a little bit of history but tell us a little bit more about how that survey was done.
Kyle Burrell 02:01
The 2022 survey was our ninth annual survey. We reach out to over 100 CFOs or CEOs at private equity and venture capital firms globally. We get their sentiments. We also interview private equity investors to see if there’s any dislocation between the way that investors are thinking and how the CFOs are thinking. Our survey breaks down responses by geography or assets under management. If those answers differ from the composite results that we get, we present those as needed. A quick plug: we’re going to be coming out with our tenth annual survey questionnaire in the next two weeks. Please be on the lookout for that. We’ll present the results of the 2023 survey in January.
Chris Gale 03:00
For this past survey, can you walk us through some of the major themes and findings and maybe surprises?
Kyle Burrell 03:06
Because there were three major themes and things we centered the survey around this last year, there was a clear importance on firms starting to invest back into their own management company. We’ll talk more about that in a second. Talent management continued to be a strategic priority for firms. Third, we tackle new product trends, like ESG and investing or sourcing capital from new channels like retail and wealth. We dig a little bit deeper into those the themes of these three sections.
At a high level, private equity firms are turning their focus to strategic decision-making. We found that important for three reasons. Number one, larger firms wanted to make sure they understood the current value of their firm as it related to what the market view of their value might be. We saw strategic decision-making assisting firms in committing to paths that create additional value. They did that using their firm’s own data, competitor data, and then market sentiment to try to help make more informed strategic decisions. Important strategic decision-making also protected firms against making decisions that would have negative consequences, like disrupting their brand or their value.
We saw an uptick in transactions taking place at private equity management companies. Whether that meant the sale of minority shares of their equity, whether it meant borrowing debt at the management company, whether it meant being acquisitive or looking to be acquired, or even an IPO – we saw things like that. Getting their arms around their own valuations was definitely a priority over the past year.
On the talent management side, it’s clearly a main focus. It has been for several years. But it was still one of the highest strategic priorities that we found as the firms continued to grow, especially as diversity, equity, and inclusion initiatives with a focus on gender and racially and ethnically diverse representation were among management’s strategic priorities as they expanded. More broadly, hiring and retention of talent were high on the priority list as these firms grew in AUM. Last but not least, as I mentioned, we looked at fun product trends, and a growing number of firms were offering ESG products and expanding their offerings to meet investor demand. Aside from the recognition that it’s the right thing to do – to be investing in ESG-friendly companies – there was a lot of pressure from limited partners to do so. There is increasing recognition of the value that sustainability can create in creating tangible value at the portfolio company level.
Another piece on the fun side is thinking about how private equity firms can increase their capital base beyond their traditional institutional or LP base while looking at retail and wealth channels as regulatory restrictions have started to subside globally. Related to that is using innovation essentially to try to access those channels.
Chris Gale 06:40
You saw something specific about carried interest, however.
Kyle Burrell 06:51
Yes. So on the carried interest side, we did ask some questions about engagement and retention of talent and what firms were looking to do private equity has the unique characteristic of being able to provide carried interest as a lever and compensation. So we looked at it from both the front office and the investment professional side of the house. But we also looked at the support – the finance professionals, investor relations, and the HR group. What we saw on the front office side, from the investment professionals, was that non-directors of the firm, almost 90 percent of all investment professionals or more than 10 years of experience were being given carried interest as a form of compensation. That was regardless of firm size. Whether you’re the biggest firm or the smallest firm, 90 percent of the firms responded that they were providing carried interest to the most tenured of employees. There was a clear drop-off after that 10-year level. So if zero to 10 years, they were giving less. The firms were not providing carried interest as much as they were to the more tenured professionals on the back office side of the house. The larger firms, 80 percent of the firms surveyed, had paid carried interest to back office employees that were over 10 to 12 years tenured 60 percent of the firm’s pay carried interest. Twenty percent only paid carried interest to employees five to 10 years. And only 6 percent of firms responded that they were providing carried interest as compensation for employees one to five years.
Chris Gale 08:45
You’re covering sets of non-partners and partners? Employees, then.
Kyle Burrell 08:51
We’re looking at non-partner employees, yes.
Chris Gale 08:54
That makes sense. Ryan, let me turn to you. EY has looked at this holistically across the industry. What is PFA saying in terms of carried interest acting as a lever?
Ryan Burger 09:14
Thanks, Chris. Great, great points. Kyle, the EY survey always has fantastic insights across private equity, CFOs, CEOs, and from the LP perspective. I completely agree with some of the points that Kyle brought up on carried interest being a lever. We are a software vendor that is helping firms track these details as well as the vesting schedules and helping firms produce reports on their carried interest and other compensation details. We’re in the thick of it every day and certainly see a variation where some firms give carry to every employee, and some firms have the level-based rewards. There are all kinds of different methods to compensate employees for base bonuses, benefits, and so on. Some individuals value flexibility. A lot of PE firms and VC firms are thinking about that, as well. How can they make sure that people are happy? Is that the type of work they do? Is it the work-life balance? Is it the flexibility arrangements? Obviously, compensation is a huge part of that. It drives people. Kwame Lewis made a good point in one of our past webinars. He was a CFO. He mentioned that private equity professionals and venture capital professionals wake up every day thinking that they can help build their businesses to reap rewards on a long-term basis, and carried interest is a big component of that if the firm succeeds. There’s that incentive to make those rewards long-term. We were definitely helping a lot of firms manage this data.
A big trend that we’re seeing is transparency so firms can provide analytics and better reporting to the employees. We’re seeing some firms that are taking that proactive approach because there are other jobs out there. It’s a huge, growing market, even with the potential recession. Firms still want to be on the offensive and make sure that they and their employees can see the overall benefit long term of having these types of systems. So we are seeing those proactive firms wanting to better digitize the data and provide better transparency to the employees so that they don’t face attrition. We are seeing some companies that have faced attrition. They believe that if the employees had better insight into the current value of their awards, and the potential future value of the awards, maybe they would have stayed longer or thought twice before leaving.
A big chunk of our conversations and our business is firms that just want to improve the operational aspect of managing carried interest vesting schedules, making sure that they can manage joiners, leavers, all of the complexities that go along with this data and the creative ways that firms compensate their employees. We’re seeing an overall inflow from an operations perspective.
Chris Gale 12:53
Sometimes a CFO or somebody who wants to adopt some degree of automation has to take on some political risk. People ask about automation, “Why can’t you just do that with Excel and email?” Are there any particular triggers or types of firms where you’re seeing them be more likely to make a break with what they might have been doing previously?
Ryan Burger 13:38
It’s really across the board. We have some new clients and some prospective clients that are two to three years old. They have one or two funds, maybe some pre-fund deals that have some carried interest associated with them. They want to start a clean slate, to have a good framework to manage all of this information. We have one new client that had 100 leaves. Nobody has left and forfeited carried interest. But they want to make sure to track all of this information in a system and be able to produce previous reports.
We are seeing some early-stage firms. The bulk of new, prospective clients are firms that have two, three, or four funds, maybe some co-investments or SPV entities. They’ve had a couple of people that have left. They’ve had promotions and new joiners come in. They may have had one or two distributions so far. They start to see that this can’t be managed in spreadsheets long term. So they seek out different platforms of service providers that can help them manage. They know they will grow and things will get more complex and complicated. Then there are really big firms that have been around for a while that have as many as 100 different plans. They might have a spreadsheet and add different tabs, each one representing a person, and a report that has calculations and formulas embedded. They know that they want to migrate over to a solution. We’re seeing across the board that it’s that innovative mindset of firms that want to do something better, improve efficiencies, improve controls. I can’t really pinpoint an exact client type, but we’re seeing it across the board. Firms that want to do something better with this data to better provide better transparency to the employees.
Chris Gale 15:33
I’m thinking of a friend who, sadly, has had some turnover in her finance department. She can bring in help, even contractors, but then somebody, like you’re saying, has to look through that Excel sheet, and all the different tabs and explain how it works. Kyle, can you share what EY has seen in 2023?
Kyle Burrell 16:30
In private equity, we put out the poll survey and, every quarter, we saw deal value declining, from the first quarter of last year. There is still a great deal of deal value taking place. It’s just that we were coming off a record year of $1.2 trillion of capital being invested. It’s hard to match the best-year private equities ever seen. But we did see a decline of 27 percent from the first quarter of last year. Geopolitical uncertainty and the impact of the war in Ukraine is continuing to have downstream effects. The price of commodities, impacting portfolio companies, has soared. We’re watching that. And then just in general, pe exits declined by 55%. In the first quarter of 2022. As I said, the deal activity remains robust. But we’re definitely in a more uncertain period compared to last year, which has the potential to create headwinds for new transactions. You also are dealing with supply chain disruptions, elevated labor expenses from inflation, and the cost of borrowing going up. We’re definitely watching to see how that’s going to impact the private equity market. But there’s still a lot of capital to be put into play here by the private equity firms.
Chris Gale 17:59
Before the call, we were talking a little bit about the headlines about recession. Ryan, do you have any observations from a PFA standpoint about how to think about carry in the near future, and how to think about managing carry going into that environment?
Ryan Burger 18:24
There’s no doubt we’re going to have some changes from an economic perspective over the next 18 months. From our perspective, we’re not seeing things change. From a technology offering perspective, we still have firms that are engaging us to manage compensation information. This industry, private equity and venture capital, has a long-term horizon from a lifecycle perspective. So we like to think that our clients will continue to embrace improvements to control efficiencies, retain their employees, and make it through to the other side if we do face base a recession. We’ll continue to stay busy on our side as we onboard more and more clients. Firms that embrace technology changes and efficiencies will ultimately be in a better position, should we face a recession.
Kyle Burrell 19:45
Private equity is still a maturing industry. It’s still in the maturing stage. One piece of that that the survey has found in previous years is that management has really focused time and effort to operationalize the growth on the fund side. We’ve got the operational side of the fund house set. We’ve invested in technology there. I think they’re turning now to themselves and maturing the business portion of their own business, which includes technology investments. Our survey asked that question. Last year, 80 percent of firms said that the investment related to their management company has increased in the past two years. You’re seeing a look at how they can continue to mature their operations, which includes their technology investment and, and the management company.
Chris Gale 20:47
We have gotten to the Q&A part of our conversation. I have three questions. The first is, this conversation has been focused on carried interest. From a fund accounting perspective and operations, how does that connect to fund accounting and operations for the full firm? Is there a linkage? PFA is also looking at how carry links into the broader finance teams’ picture and that side of things.
Ryan Burger 21:48
We manage all the individual employee allocations. However, that does connect to the fund accounting side where waterfall calculations are run on a quarterly basis. If a firm is in the money, and there’s carried interest that’s accrued to the GP entity, that information is then brought into our system to allocate down to those individuals. So we are seeing a lot of firms wanting to enter that information into the system. So say there are a million dollars in accrued carry for a given firm. They enter that information in FirmView, letting it allocate down to individuals, and then producing statements where individuals could see what’s vested and non-vested. That’s where we are having a linkage to the fund accounting side. It’s even more so for deal-by-deal firms where the components on the deals are then synced into our system where employees can see, for every deal or investment tranche, how much carry is accrued or if there’s negative carry for certain deals because they are underwater. We are creating that linkage to the fund accounting system for several clients.
Chris Gale 23:14
We’ve been focusing on private equity in this conversation. What about venture capital? Are there parallels or differences?
Kyle Burrell 23:30
I can only start from the survey side. Our survey incorporates both private equity and venture capital. We’re seeing very similar results operationally, whether you’re PE or VC.
Ryan Burger 23:49
We serve both PE and VC. The VCs are our fastest-growing client type right now. There are a lot of nuances. The AUM might be smaller, but there may be a lot of funds, a lot of separately managed or SPV entities, a lot of vesting schedules, and a lot of advisors. They want to track all this information in a single system. We’re seeing a huge influx of VCs wanting to use our platform, but generally, the characteristics are similar. Some of the venture capital firms will have extra performance kickers on vesting schedules. We’re seeing some different components there. But generally, it’s a similar structure between private equity and venture capital from a carried interest and incentive perspective.
Chris Gale 24:44
So you’re saying that the VC is smaller, but can be more complex?
Ryan Burger 24:49
Yes. The VCs may provide some carried interest across the entire farm versus the big private equity houses – to Kyle’s point earlier – might be only providing it at the most senior level. Some very large PE firms provide it across the board. There are some VCs that don’t provide carried interest costs because you have to think about that holistically.
Chris Gale 25:35
The last question, Kyle, is clearly for you. For the upcoming survey, how do individuals participate? Is there a proactive way?
Kyle Burrell 25:59
It gets rolled out to as many people as Ernst and Young has – you know, relationships. Whether that’s through our audit side or advisory side or tax side, we try to reach out to everybody. If you have not received the survey in the past, please find me on LinkedIn. I’ll make sure the survey results get to you personally. We welcome as many advisors and investors as we can get to participate in the survey.
Chris Gale 26:30
Great. That is it. Thank you very much, Kyle, for joining us. Thanks, Brian, and everybody. We’ll be in touch. Thank you.
