Private equity is supposed to be the promised land. Spend a couple of years in the tumultuous world of investment banking, before beating the (stiff) competition for a move to the buy-side for more pay, better work life balance, and – importantly – job security.
Private equity firms rarely fire people, and lock senior staff in with carried interest that is simply too good to walk away from. But what if they’re all doing it wrong?
A new study by academics at London Business School, Saunder School of Business, and the University of British Columbia challenges the notion that team stability is important for private equity firms’ performance. Firing under-performers and bringing in new blood to adapt to a changing business environment is exactly what private equity firms need, it says.
It has come to this conclusion after examining a hefty 138 firms, 5,772 deals in around 500 companies and 5,926 people over 20 years.
“Contrary to the belief among private equity investors that turnover is disruptive, our results suggest that turnover has, on average, a positive effect on PE performance. Thus, this obsession with team stability may be unwarranted,” it says.
Stability is over-rated
If a key individual leaves a private equity firm, chaos ensues. The firm freezes fund-raising efforts and new deals are non-existent as the firm works out how to untangle the often 20-year career of a private equity partner.
“Partner to partner moves simply do not exist,” says Gail McManus, managing director of Private Equity Recruitment. “They have carried interest tied up in at least three funds, so have too much to lose. The only way they keep it is by being a ‘good leaver’ – that means cutting a deal to keep the carry, not working anywhere for 12 months and never working for a competitor.”
The study pointed to how private equity funds boast of ‘stable’ teams in order to impress and attract investors. The contrast with investment banks could not be more apparent. Investment banks have plenty of ‘lifers’, but they also cull the bottom 5% of under-performers annually as a matter of course and fire decidedly more than that when the business environment turns sour – like now.
As a result, junior bankers have been clamouring to get to the buy-side – often negotiating offers just six months into their banking career – and are leaving for a PE role ever-earlier.
The junior churn
More private equity firms are offering analyst programmes and recruiting graduates straight out of university (normally straight-A students with a couple of banking internships). It’s here where the fall out is.
“When I got promoted to associate, I knew I was in a stable job,” says one private equity associate who was promoted last summer. “Up until that point it’s like a temporary contract - you have two years and there’s no guarantee you’ll make the cut. Around 30% of people don’t.”
McManus says that a lot of private equity firms hire associates for two or three years with no promise of a job at the end of it. “Even then, it’s not so bad – it’s not like being fired really. You have a large private equity firm on your CV and you can easily get another job at a mid-market firm or even a competitor.”
The study suggested that the average age of people on deal-making teams was 37.42 and that the average experience level is 6.03 years. 29% of these people had an MBA (and 81% of these from a top business school), but financial sector expertise (48%) was by far the most prevalent skill.
“These results suggest that what matters in the long-run is not hiring individuals who can better restructure existing investments, but rather hiring individuals who bring in fresh ideas and skills to the team, or who are better suited to source and run new investments,” it says.
The study ran over 20 years, but McManus says that moves are more prevalent in private equity these days anyway: “Juniors have more selectability and are not tied to one organisation. Most people have three or four moves on their CV now and it’s not frowned upon as it was before the financial crisis.”