Modernisation of carry allocations is set to accelerate over the next three years as private equity fund managers move to more flexible and inclusive models, new research* from Ocorian, a leading U.S. and global asset services provider, shows.
The study, which surveyed private equity managers across the U.S. and Europe collectively managing $3.511 trillion, found that 84% expect the pace of modernisation to increase, with fund structure complexity, regulation and tax issues being the key drivers of change.
Research across key U.S. markets, the UK, Switzerland, Germany, Italy, Spain, Poland, Sweden and Bulgaria found alternative phantom equity pools are currently the most widely used innovations, while points systems for legacy deal inclusion will see the most growth over the next three years.
More than half (54%) questioned currently use alternative phantom equity pools, while 53% use shorter vesting and retention hooks and 50% use points systems for legacy deal inclusion. Around two out of five (37%) focus on broader participation as an innovation to carry allocation.
Looking ahead, 60% expect a dramatic increase in the use of points systems for legacy deal inclusion over the next three years, while 56% expect the same for the use of alternative phantom equity pools
Fund complexity, regulation and talent are driving change
The study identified fund structure complexity, regulatory change and tax developments as the primary drivers of changes to carry allocation. More than a third (37%) say complexity of fund structures, including continuation vehicles and longer fund lives, is creating a need for more flexibility while 33% say regulatory and tax changes, including UK reforms, are making changes necessary.
Around 10% of firms are already using tiered performance-based carry, where carry rates can rise above 20% when higher return thresholds are achieved. depending on higher return multiples, while 90% are considering it.
Balancing broader participation with LP protection
The survey also found carried interest or other equity-linked compensation is increasingly being shared with non-principals, with 82% reporting a slight increase over the past three years and 11% reporting a significant increase.
However, there is also more demand from LPs for stronger protection against over-distribution with 92% reporting an increase.
Brendan Dowling, Head of Employee Incentive Services at Ocorian, said: “Carry allocation practices are continuing to evolve, and our research suggests this evolution is likely to accelerate over the next three years.
A range of factors are driving this shift. Chief among them are increasing regulatory and tax scrutiny, alongside the growing complexity of fund structures and incentive arrangements, all of which are creating a greater need for flexibility.
Competition for talent is also influencing how firms structure carry. There is an increasing focus on creating reward mechanisms that are more transparent and better understood by participants, contributing to a broader trend towards wider participation in carry programmes.”
The table below shows which innovations to carry allocations private equity fund managers expect the use of to increase the most over the next three years.
|
Carry innovation |
Percentage expecting use to increase dramatically over next three years |
Percentage expecting use to increase slightly over next three years |
Percentage expecting use to stay the same over next three years |
Percentage expecting use to decrease over next three years |
Percentage saying not applicable |
|
Broader participation |
25% |
53% |
22% |
Zero |
Zero |
|
Point systems for legacy deal inclusion |
60% |
17% |
20% |
1% |
2% |
|
Alternative phantom equity pools |
56% |
20% |
22% |
2% |
1% |
|
Impact-linked carry |
32% |
25% |
41% |
2% |
1% |
|
Dollars at work reporting |
23% |
38% |
32% |
1% |
6% |
|
Shorter vesting and retention hooks |
25% |
28% |
42% |
2% |
4% |
|
Portfolio level/deal specific allocation |
34% |
37% |
27% |
1% |
2% |
|
Earlier in fund life incentives |
23% |
55% |
20% |
2% |
Zero |