Bang! You lose your investment team in one go! This is what happened to one of my fund management clients recently. The investment team left to launch their own fund backed by a blue chip investor who saw magic in them. The main principal of this team who also happens to be a friend of mine, quoted one main reason which will resonate with most senior professionals working for a founder lead business: “Inequity in Founder Economics”
Most Founders always keep the lion share of the profits and retain control no matter what.
Why? Because they took the risks and built it to what it is today? OK. That is fine up until the point the founders are truly the ones playing the main role in sourcing / exiting investments and raising money for their funds from a network of investors who trust them because of their track record. However, what happens when the founding partners have built a Galactico team and a strong AUM size over time which now runs “auto-pilot” without much help from them? What happens when they get comfortable earning “rent” from their management fees and lose the ambition to continue growing the firm or to develop new innovative products on their platforms? Once you have $5bn of AUM, that equates to $100m of pure management fees every year in asset classes like Private Equity. With those kind of numbers, how motivated would the founders be to give away more equity and potentially control in the management company to the future partners who could potentially take the firm to new heights?
When the managing partner/controlling shareholder(s) really understand what giving more equity and control can do to the long term value of the company and its legacy that is when they will be able to bring true innovation to the business and can create a company that can transcend generations. This could be one of the main reasons why so many firms are unable to break the multibillion-dollar fund mark. It is not necessarily because of performance or fund raising reasons – it is usually because the founders of the business don’t want to give up control and equity which stems the earning potential of the company in the long term.
Look back through the lens of history when the executive CY Lewis of Bear Stearns rejected repeated proposals of innovation to set up a dedicated fund within Bear Stearns and objected to the amount of time spent on outside activities which ultimately pushed Kohlberg, Kravis and Roberts to build KKR to gain control of their aspirations. Thousands of spin out stories can be related. Think back at how Blackstone partners left to create Centerbridge back in the day and how even till today we see partners and principals leave to set up their own funds.
The main reason cited by entrepreneurs when asked why they set up on their own is to take control on their deals and take a larger share of the carry. I am certainly not saying that all Partners should get a free ride, but if someone has raised capital, made quality investment decisions and exited a fund with top quartile performance, I think that person / team deserves a bit more than just a few percentage points of carry/performance fees/bonus! Carry is easy to give but equity and control is where fund managers (founders) fail to deliver.
“Pay your investment professionals well enough so they don’t leave” – this has become a boring cliché in the eyes of the market. Locking in fund management talent is not just about giving them extra carry or bonus or higher salary. What we don’t talk enough about is executive compensation and concept of giving away control and how that should be structured or at least presented to the team to ensure that your whole team doesn’t leave! The irony of how Private Equity firms dedicate 10 years of their fund’s life to growing firms by locking in key talent within portfolio companies with equity, sadly are often unable to accomplish the same success when it comes to developing their own Private Equity businesses.
In one of my next blogs I will write some points about how we should structure compensation and equity to simplify this issue. I would also love to her from industry professionals / general entrepreneurs out there that had similar issues or just your views in general.
Ayyaz Ahmad is Co-Founder and MD of Funds Partnership, a specialized funds focused executive search firm with offices in London, Luxembourg, Amsterdam, Singapore and Hong Kong.