In a world of slow economic growth and subdued financial markets, founders of both hedge fund and private equity companies are adjusting their ambitions. Realising that they might not be able to sell out after a few profitable years via IPOs or trade sales, they’re beginning to look more into developing and instilling a culture that motivates valued employees and creates a pool of potential successors.
Across the alternatives sector, we see founders reviewing the futures of their businesses, seeking ways to bridge the gap between themselves and their senior people. They’re looking into both remuneration structures and broader culture and ‘feel’, questioning whether accepted practices still work.
While financial markets appear relentlessly bleak, star-quality employees remain vital to both hedge and private equity firms. We believe that alternative investment management firms must develop both ownership and incentive structures that strike a balance: they should give key staff the incentive to work towards a successful exit (where the founders have this aim), while also supporting long-term financial performance in case the business continues to be independent after the founders have retired.
Looking to the longer term requires a new approach to talent management – especially at a time when some founders are close to retirement, making planning for the next generation especially important. You need employees with the right skills and characteristics to take over management of the business at some point. Honestly assessing whether you already have these people is the first step in succession planning.
Once you’re sure you have the right people in place, you can plan the structure of remuneration and broader cultural issues. Short or medium-term incentives, including a share of the exit proceeds, are unlikely to be sufficient. Instead, alternative investment management firms have to find ways to attract and motivate the ambitious, driven people they need over longer periods of time.
Recognising the importance of talent management and succession planning for the sustainability of alternatives managers’ businesses, prospective investors are scrutinising them when deciding whether to make allocations. So you need to show that your policies for attracting and retaining star employees have adapted to the tough market conditions.
As if this were not enough, regulation is complicating matters further. The AIFMD states that alternative investment fund managers will have to disclose more about senior executives’ pay and will have to pay more in equity-type instruments. What’s more, AIFMD tilts the playing field between new and existing employees – alternative investment fund managers can pay the former guaranteed bonuses but not the latter.
The days when alternatives managers simply paid large packages based on salary and performance are unlikely to be fit for purpose in the new world. For larger private equity firms, fund-by-fund carried interest may no longer be sufficient to incentivise long-term loyalty. Instead, alternatives firms might look into paying their senior executives and future stars in a similar way to the owners of the business. In this way, they create a culture of ‘ownership’, encouraging the people judged essential for future success.
But you need to think carefully about such an approach. Telling people that you view them as owners of the business is dangerous if you don’t then reflect this by, for example, letting them influence both operations and future strategy. If you don’t have people in role with the right qualities, then outside hiring may be a necessity for succession planning.
Pros and cons of partnership structures
When planning the right model for the future, both partnership and corporate structures have pros and cons. Partnerships are far more flexible for defining how ownership works, including how different people have different rights and setting out the circumstances in which they might be taken away. What’s more they’re often more tax efficient than corporate structures.
From a cultural perspective, a partner is one of a select group of people responsible for owning and running the business. A partnership defines the people who control the business and requires them to assume responsibility. In doing so it can solve the issue of succession planning and motivate key employees — provided the right people are in place.
One of the drawbacks is that partnerships only allow for profits to be shared between the partners. So you cannot allocate any share of your profits to star employees outside the partner group. You can bridge this gap by developing remuneration models for employees that mimic the partner model — although perversely some employees have been known to view this negatively, asking: ‘why not make me a partner then?’
In the changed environment, we see a lot of alternatives firms wrestling with remuneration and succession policies that no longer work. Strategic succession planning has become more important than ever. What’s more, confirming people’s role in the business gives them huge relief at such an uncertain time, fostering exactly the kind of loyalty you want.