Kevin Ye, partner at US-based corporate advisory service Mach49, and Paul Holland, managing director of corporate investing practice at Mach49, tackled the topic of carried interest and compensation in the world of corporate venture capital.
Ye acknowledged that it can be “a very sensitive conversation for many”. Holland described a hypothetical example of a traditional venture firm that has raised $1bn fund, with four general partners (GPs) and staffed four other junior team members. The fund applies the standard 2/20 fee structure, that is – a 2% management fee charged over assets under management every year and a 20% performance fee on successful exits and over profits once realised.
The 2% management fee implies that the hypothetical fund would have $20m to cover all expenditures, of which – according to Holland – roughly $16m would go to cover compensation expenses. Of those $16m, about $2m would be spent on basic salaries and the remaining $14m would come in the form of bonuses, mostly for the GPs. Ye and Holland said that sometimes people forget about the share of bonuses but also pointed out that there is usually a cap on how much of the management fee may be spent on compensation and bonuses.
In terms of the carried interest (or “carry”) off the 20% performance fee, Holland pointed that historically it has been the GPs that have kept a larger share of realised profits and junior team members a much smaller amount. He warned against being in a situation where you are undercompensating junior members that have made tangible contributions for successful exits: “Try to make sure you are not in a situation where someone who is a top performer gets the same amount of “carry” as someone who did not perform as well.” He pointed out this is the reason why compensation structures as “shadow carry” are sometimes put in place.
In the context of the positive evolution of corporate venture capital and its further professionalisation, Holland noted the need for proper compensation in order to retain talent: “The reason compensation needs to be where it needs to be is that there is an arms race for talent. You are competing with PE firms, large corporations and others who are going to have other ways to compensate more generously such people…To have the best people, we have to compensate them properly or they will just go somewhere else.”
However, Ye also addressed challenges on adopting traditional VC compensation incentives in the context of corporate venture capital. Such hurdles include but are not limited to: corporate HR and compensation policy, the potential costs of having carried interest compensation for the corporate parent as well as the potential to create severe inequality in compensation compared to other executives in the organisation.