Private Equity Salary Freeze

6 of 10 Surveyed Private Equity Firms Freeze Salaries

Private equity firms offer highly competitive compensation packages which is a major factor in why the industry has been so successful at attracting talented young professionals and keeping experienced management satisfied.  But as assets under management and performance fell, so did the revenue buyout firms earn from fees; as a result, many firms had to cut costs by reducing compensation and lowering recruitment offers.

Earlier this year I noted a trend in compensation in which larger buyout firms were cutting salaries and bonuses while smaller firms were increasing compensation.  This was most likely a play by smaller buyout firms to attract top tier talent while the industry was suffering most in the recession.  Bigger buyout firms with larger staff recognized the inevitable need to cut costs and at a time when the financial industry’s future was uncertain it was unlikely that cutting salaries would lead any staff to quit.

Now, it seems that the smaller- to mid-sized private equity firms are having to make the tough decision to freeze salaries.  The 2010 Preqin private equity compensation and employment review estimates that 6 out of 10 private equity firms have frozen salaries or plan to do so.  In response to the economic downturn and heavy losses over the 12-18 months, 38% of surveyed buyout shops froze salaries and 22% are considering doing so.

My view on this news is that this is not unexpected given the current state of the private equity industry and compensation is still very good but this does give recruiters from competing financial industries a chance to lure private equity professionals.  I would not be surprised if more private equity firms try to trim expenses further with pay cuts over the next few months, at least until deal flow returns to a normal level.  Until then private equity firms are at a disadvantage to the remaining investment banks that have made a swift recovery and hedge funds.

Goldman Sachs and the Surviving Investment Banks

Consider Goldman Sachs: the firm made national headlines for its remarkable turnaround and surprisingly high earnings.  In the first three quarters of 2009, Goldman Sachs has put aside $16.7 billion for employee compensation and it is reasonable to assume that the investment bank will be able to draw talent from other industries and firms ravaged by the financial crisis. (See story on Wall Street bonuses)  Goldman Sachs and the other surviving investment banks will probably be able to leverage their returning clients and increasing AUM to revive compensation packages and strengthen recruiting.

The Return of Hedge Funds

Hedge funds are on track for a record year and a recent estimate predicts hedge fund assets under management to reach $1.75 trillion by the end of 2010.  Hedge fund performance has consistently increased through 2009 with only a slight drop last month.  Investors are expected to flock back to hedge funds as they become more confident in the industry.  Hedge funds typically generate quicker returns to investors than buyouts which make long-term investments and may take years before making a profit.   This has probably pushed the hedge fund industry above private equity in terms of recruitment although hedge funds are not seen as the safest employers given the scandals and failures of even top-tier hedge fund firms.

Conclusion

Overall, it’s safe to assume that private equity firms face stiff competition from hedge funds, traditional investment firms, and investment banks.  The fact that 6 out of 10 surveyed firms have frozen salaries does not help recruitment and the maintaining of veteran staff but poor-performing hedge funds and I-banks are in a similar situation.  Interestingly, 43% of surveyed firms actually increased bonuses so buyout firms may be aware of the competition and trying to keep hold of good employees and executives.  If the buyout industry can make a similar comeback as hedge funds or some investment banks, we can expect to see bonuses rise again and salaries slowly increase. 

Here is more on the salary freeze from the WSJ:

“The salary freezes are more common at the top,” said Tim Friedman, a spokesman for Preqin. “More junior level staff are receiving increases because it is more important to retain their salaries high.” He said this is because junior staff often have a less-vested interest in the firm via carried interest, so they need salary increases to motivate them.

The general trend to freeze salaries was accompanied by firms reining in bonuses. Nearly half of firms, or 43%, cut bonuses, with the payouts falling 40% on average.  Still, another 43% of firms increased bonuses, with bonuses rising an average of 21% at these firms. Bonuses remained flat at another 14% of firms.

About 14% of firms have reduced staff, and a further 12% are considering doing so, Preqin said.  According to Neil Macdougall, managing partner of U.K. midmarket buyout firm Silverfleet Capital, the squeeze on salaries isn’t as important for those executives who are confident that in the long-term they will receive carried interest, or the cut of the profit that private-equity firms receive on their investments, typically 20% of any profit.

Read more on private equity compensation here.
Watch a video on Private Equity Starting Salary here.
Also see Private Equity Salaries Increase

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