The importance that new PE and VC Fund Raisers should attach to their remuneration strategy, particularly for their investment teams

According to a recent private equity news publication, 449 European Private Equity backed transactions worth an estimated €70bn were announced in the first three months of 2021.  Interestingly nearly half of these deals, both in number and size, were done in March.  This more than substantiates anecdotal reports that the private equity investment community is busier than ever despite the challenging macro-economic conditions across Europe.

Whilst there might be some skepticism as to whether this sort of deal rate can be sustained in mainland Europe given the significant headwinds that these countries will be facing because of their third waves of the pandemic, in the UK we have cause to be more optimistic.  Indeed, half of all these deals involved UK or Irish headquartered businesses.

It was not only the deal teams that were very busy in Q1; fundraising and Investor relations teams were also pretty flat-out increasing the already staggeringly high volume of dry powder in the PE and VC industry.  Statistics show that around 60 European focused funds closed in the first quarter raising circa €64bn in total.

Somewhat disappointingly, but perhaps not surprisingly, very few of these new funds that were raised in Q1 were first time funds.  First-time fund raising fell in 2020 as the LP investing community had their eyes on their existing GPs and ones that they knew well.  There is no doubt that the Covid pandemic hindered the chances of new fund raises as due diligence became much more difficult, in particular because face to face meetings were essentially a no-no.  One commentator suggested that capital raised by European first-time funds fell nearly four-fold in 2020 down to less than €2bn.  In contrast, 2020 as a whole still saw the second highest annual total for European fund-raising over the previous ten years.

But with the success of the vaccine roll-out in the UK and with travel restrictions becoming more relaxed, there is a growing optimism that 2021 could see a strong recovery in new first-time funds.

MM&K often finds that when a new fund is being raised by a PE or VC house, that is the time for that fund manager to have a good look at its compensation structures and strategies, and in particular its short-term and long-term incentive arrangements.  With a new fund in place, more management fees coming in and a new carry plan being required, it is crucial that careful thought should be given at that time to who are the key members of the team and how many new recruits will be needed.  At this time GPs really need to have a good handle on what the market is doing in terms of levels of pay, both fixed and variable, for investment professionals and senior back office staff.  In particular they will need to make sure that the carry is allocated appropriately to the members of the team in a way that ensures retention and motivation of their key investment staff, whilst retaining sufficient capacity to attract new recruits as and when needed.

LPs looking at investing in new funds really want to know who the important team members are and that they are being properly paid and incentivised.  They also want to feel comfortable that if the business plan envisages that the team will need to grow in size, that the structure of the carry plan and any annual bonus plan, leaves adequate capacity for this.  This need-to-know attitude of fund investors is particularly acute for first time funds.  LPs want to see that the founding partners of such firms have carefully thought through how much the team will need to be paid and how much carry will need to be handed out to them, to give confidence that the firm will be able to attract and retain top quality talent in an ever (seemingly) increasingly competitive talent marketplace.

MM&K has itself been very busy over the last six months advising firms that are in the midst of new fund raises on all these types of issues.  The fact that we have been advising our clients on such matters and that we have been running our PE and VC compensation survey for over 25 years, places us in an unrivalled position to help firms trying to grapple with such issues, particularly when it is for their first time.

For any such firms that are in the process of fund raising that want to review their approach to compensation and incentivisation, a good place to start would be to participate in MM&K’s 2021 UK and European PE and VC Compensation Survey.

For further information or to discuss how MM&K can help in such situations, please contact Nigel Mills or Margarita Skripina.

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