What is Private Equity Compensation: A Simple Guide

With 11,273 U.S. businesses being backed by private equity firms, more and more companies are utilizing the accessibility, and the ease of access private equity firms can give them. That said though, there is only so little a firm can do to help when it comes to a company’s success.

However, private equity compensation is so much more than just a salary for private equity employees. With the right tools, private equity compensation can be used to create a more streamlined compensation strategy for a company.

Thus, read on to learn more about private equity compensation, how does it work, what’s included in it, and most importantly – how it can be used to ensure fair pay within the company.

What is private equity compensation?

Private equity compensation refers to the payout that private equity employees receive. Oddly enough, although most sources state that private equity firms pay their employees the same, some private equity firms pay their employees more if the firm they’re investing in either succeeds or sees record growth.

Think of the correlation between private equity salary and companies as a mutualism relationship: a portfolio company invests their own money to earn a better salary, while the companies they invest in can get better cashflow going their way.

The investment made by private equity firms also ensures that the invested companies can have a better overall cashflow – and combining that with a good compensation planning software, ideal market conditions, and investment returns ensures that everyone involved will have a better base salary along with better salaries and bonuses.

How does private equity compensation work?

The system works similar to the already established compensation system that most companies already have in place, but only this time, everyone involved can get twice - or even thrice – the regular salary if the invested company either succeeds or gets sold.

This gives the private equity companies a further incentive to go above and beyond and provide as much help as they can to the companies. Whether it’s sourcing new ways for company growth, giving them new ways to scale, or even providing them with the cash flow that they need to grow further.

General overview of private equity compensation

In the theoretical situation that the private equity fund does bear fruit, the employees working for the private equity firm can see better compensation. The private equity compensation structure can be classified into base pay, percentages, and carried interest levels.

1. Base pay

   Although there are plenty of sources that state differently, the general base pay for private equity firms averages around $100,000 to $750,000 per year. Analysts make the least amount of money, but it comes with the caveat of career growth after a couple of years.

   Vice Presidents (VP) have the ability to earn significantly more than the analysts, senior associate, and managing directors combined, but it also comes with limited career growth as it's already considered the highest possible role.

2. Percentages

   As mentioned above, private equity employees receive bonuses when the company they’re funding receives a positive reception. The bonus usually comes in the form of percentages, usually 2% annual management fee, with some firms even going as far as gaining 20%, meaning that the percentage changes on a deal-by-deal basis.

   That said, the most common business practice for private equity firms is to sell the company that they’ve bought for more than they bought it for – in that case, the employees can earn up to 20% of their regular salary as a bonus.

3. Carried interest levels

   Simply put, carried interest is the share of profits that private equity firms make after the investment has been made. Think of it as investment profit - if the fund performs significantly more than expected, and which drives the total compensation better. Everyone can expect higher compensation for company success, or the company being sold altogether. The overall value of carried interest also varies on the fund's performance, which means it can either be mega funds or as little as a salary bonus.

   Commonly, carried interest is considered as a return on investment, and is typically only taxed at a lower rate since it’s classified as capital income rather than a regular one. It’s also taxed at a lower rate than regular pay since it’s technically considered capital gains.

   Carried interest also defers taxes similarly to unrealized capital gains, especially when considering the fact that it’s distributed after a period of years.

How does private equity compensation ensure fair pay?

Simple – the money private equity firms provide companies can be used to create better cash flow, which in turn allows them to invest in other ventures that can help them grow further. From better strategies to acquiring a tool that can help them assess pay gaps, the money can be used to pay for plenty of things. The catch up clause that the vast majority of PE firms also ensures that the deal execution benefits both companies as well.

Though situational, private equity companies also provide the companies they’re investing in an improved working condition. They can provide help to every employee, whether they’re tipped workers or not.

FAQs about private equity compensation

Here are some frequently asked questions about private equity compensation.

What is the purpose of private equity compensation?

Its main purpose is to incentivize bold investment decisions that are either hit-or-miss on smaller firms that may or may not generate high returns. Investors are incentivized through their base pay, percentage, and carried interest rate.

What is the standard for private equity pay?

Usually, employees can get at least 2% of their investment after they’ve invested in a company. However, it can go up to 20% if the company they invested in succeeded, if the company has gathered larger funds, or gets sold at a higher valuation.

What does carry interest level mean?

Simply put, carry interest works like a salary that's received after the initial investment has been made. It's paid only after either a milestone has been reached, the company has generated profits, or after a minimum threshold of return, and can be compared to deferred compensation, where it can only be released after some time.

Is private equity the same as investment banking?

No. Although both investment banks and PE firms work in a similar field, investment bankers focus more on the short-term growth, whereas private equity firms deal with a company's long-term financial goals.