The stock market is not a good place to be in right now.
Many of my young friends in the financial industry said they want to switch to the buy-side from the sell-side because that would be more stable and they would face less pressure.
I admit staff mobility in private equity and venture capital funds is relatively lower.
Such funds are usually small size so there are few vacancies.
Normally it will take years for a deal to realize a return so fund managers prefer to stay longer. If there’s a job opening, applicants rush to submit their resumes.
The low staff mobility in PE and VC funds is partly due to their methods of vesting carry interest. Vesting methods are usually designed to encourage the stability of the team.
In this article, I want to discuss carry vesting and how much general partners (GP) would put into a fund.
Generally, when the chief executive of a fund decides to share a certain percentage of the carry with a new senior staff member, how much the staff member gets depends on how long he or she has worked with the company.
In most cases, a first-time fund uses a straight distribution method according to the corresponding investment period.
In other words, if we assume a typical fund has an investment period of five years and an extension period of two years, the fund will give five-year vesting period to the staff member.
If the staff member quits after one year, they will earn only one-fifth of the carry allotted.
They will have to work for at least five years to take it all. Sometimes, in order to retain a talent, a fund extends the vesting period to more than five years.
In other cases, for the purpose of retaining talents, some funds use cliff vesting, which means paying their share of the carry in one go after certain period of time, or back-end loaded vesting, which means a smaller part of carry is paid in the first few years, leaving the bigger part for later years.
Carry vesting will be adjusted according to specific situations. But the key is to motivate staff of various seniorities.
When a GP establishes a new fund, the limited partners (LPs) will require the GP or the founding team to put in their own money.
From the LPs’ perspective, the more the GP puts in, the more confident they will become about the fund.
There’s no fixed requirement. But generally the GPs will inject an amount equivalent to 1-3 percent of the funds they raised.
Therefore, for the VC funds, the founding GP will have to put in at least US$1 million in the first place. It is a high threshold for those without a track record and strong financial capability.
Some funds that report a good return in the first phase, will raise the ratio of their own money in the fund to attract investors for the second or third phases.
On the other side, if some partners can bring a very unique value to the fund, the more GPs will invest, the more carry they can get.
This article appeared in the Hong Kong Economic Journal on Jan. 14.
Translation by Myssie You
[Chinese version 中文版]
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