Anton Seatter, Director – Employer Solutions, explores how Single Family Offices are adapting to meet the long-term career aspirations of professionals in the sector…
How have career paths changed over recent years in the Single Family Office space?
Until relatively recently, family offices have been staffed with professionals who have had long-term links with the family; more often than not rising through the ranks of one of the family’s wealth generating businesses. They have tended to be lawyers and accountants and their approach would be to outsource family wealth to professional third parties to manage on their behalf.
There has been a greater need to build investment expertise in-house as over the past decade family offices have become increasingly institutional in their approach and have allocated more to alternatives such as private equity and real estate. To do that they have needed top-quality talent and that has meant looking to attract investment professionals from more diverse parts of the financial services industry – investment banks, private equity houses and hedge funds, in particular.
What has that shift meant for Single Family Offices looking to retain and reward talent?
A family office can be a really attractive career path; they are generally more entrepreneurial and do not have the same regulatory burden as the banking or asset management industry. Some professionals see them as a good way to diversify their investment expertise and many like the fact they take a long-term view rather than judging portfolio performance from one quarter to the next.
Of course retaining that talent has become increasingly important in a highly competitive job market, and for that reason family offices have begun to draw on these features and combine them with the sort of compensation structures that individuals from the investment banking and asset management industry are familiar with. Aligning their own interests with those of their employees has become critical in ensuring family offices can not only recruit but also retain top talent.
What sort of incentives are Single Family Offices typically putting in place?
In the shorter-term, annual bonuses remains very popular – research shows that over 83% (Botoff Consulting) of family offices use them as part of overall compensation, and annual discretionary bonuses can be used to reward both quantitative and qualitative performance criteria. Most family offices prefer discretionary over formalised structures as they see individual performance as being the most important factor when determining the quantum of any award.
What about more long-term incentives?
As with any employer, aligning the interests of employees with the family office over the long-term is of utmost importance too. What we are seeing is that families not only want to reward employees for making good investment decisions, they want to ensure they take a long-term view and do not take unnecessary risks. To align interest, the use of long-term incentive planning has become more widespread, especially for employees below the executive level.
Long-term incentives are attractive as their formulaic approach provides a direct link to investment returns, helping to align employees’ interests with the family office, as well as promote employee retention and teamwork. Most family offices operate one or two long-term incentive structures with co-investment, carried interest and deferred compensation being the most popular.
Can you elaborate on those a bit?
Co-investment allows employees to take a minority interest alongside the family investment in a portfolio company. The family office might help employees finance their co-investments through the use of recourse (and even non-recourse) loans. It is common for employee investments to be pooled through structures such as special purpose vehicles, employee side-funds or a general partner.
Carried interest, meanwhile, provides employees with a share of investment profits in excess of a specified return (a hurdle rate of 8%, for example). Carry can be structured directly using grants linked to profits generated in actual portfolio company interests or indirectly using phantom equity. It is a popular remuneration structure for alternative asset classes, particularly private equity.
Finally, deferred compensation aligns interests by investing a deferred cash bonus in a way that aligns to the family office’s strategy. The investment mix may depend on the award holder with the basket of investments being adapted to suit their role. Vesting usually takes place over a three to five year time horizon and structuring might be by way of an employee trust. Depending on the make-up of the family’s portfolio, these awards might include phantom equity.
How does phantom equity work?
Phantom equity essentially tracks the financial gains (or losses) of real stock without actual ownership. This can be attractive if the family does not want to dilute their investments. However, depending on the performance of the underlying investments, this can create open-ended investment risk. It is therefore common for a phantom award to be hedged in investments in similar sectors or, at the very least, other positively correlated investments.
Is managing employee incentives a challenge?
It can be. The complexity of long-term incentive plans means that it is often preferable for family offices to engage professional service providers, rather than running everything in-house on a spreadsheet. By outsourcing, the family office can take advantage of the administrator’s employee benefit focused infrastructure, their experience and their independence.
So where should a Single Family Office start in putting an employee incentive structure together?
The important thing to remember is that employee benefits in the family office space is continually evolving when compared to institutional markets. No two family offices are the same and, as a result, compensation structures vary greatly. The plan should align to the family’s purpose and plans should to be flexible enough to adapt to individual deals and take into account changing market conditions. Stretching the pay-outs over a number of years can also help to align interests over the long-term and working with independent third parties can ensure arrangements remain objective.
Critically, the best executed arrangements are those which are well communicated and provide clear parameters as to what an employee needs to do in order to succeed under the plan. And ultimately, that is what a family office wants to achieve – when its employees succeed, it will succeed too.