COMPENSATION STRUCTURES

A key area that is typically included in most investor's operational due diligence reviews of a private equity firm relates to employee compensation. The question of compensation, from the investor's perspective, effectively boils down to three primary questions. The first question relates to the ways in which the existing fund employees are compensated. This is of particular importance for an investor approaching a private equity firm during the due diligence process for a newly forming private equity fund.

The question of compensation is focused on the alignment of interest between a private equity employee and the fund in which they will be involved. Such an alignment of interest is often paramount for investors. Investors generally believe that a private equity employee whose compensation is directly tied to the performance of a particular fund will work harder on that fund than they would a fund whose performance may only tangentially affect their compensation. Furthermore, many investors generally hold the belief that private equity employees will be more incentivized to act in the best interests of the fund, as opposed to their own best interests, if their compensation is directly linked to fund performance.