Designing effective executive compensation in private equity portfolio companies requires walking a tightrope. Get it right, and you create powerful alignment between management incentives and value creation goals, driving both operational improvements and successful exits. Get it wrong, and you risk everything from lackluster performance to the loss of key talent at critical moments.
While much has been written about executive compensation in public companies – including an influential Harvard Business Review analysis of compensation design principles by Boris Groysberg and colleagues – the private equity context presents unique challenges and opportunities. PE portfolio companies operate with compressed timelines, face intense pressure to deliver operational improvements, and must balance immediate performance needs with sustainable growth that will attract future buyers. This complexity is precisely why thoughtful compensation design has become a crucial lever for value creation in private equity.
The PE Context
Private equity portfolio companies operate in a fundamentally different environment than their public company counterparts. While public companies balance quarterly earnings expectations with long-term value creation, PE portfolio companies typically work within a 3-7 year investment horizon with a clear exit goal. This creates distinct parameters for compensation design.
Time compression is a critical factor. PE objectives often involve rapid operational improvements, strategic repositioning, or aggressive growth – all while maintaining focus on exit value. This means compensation must incentivize both quick wins and sustainable improvements that will attract future buyers.
The Four Key Dimensions
Effective PE compensation design requires careful calibration along four dimensions described in HBR by Groysberg and his colleagues: fixed versus variable pay, short-term versus long-term incentives, cash versus equity, and individual versus group performance metrics.
While public companies typically make about 82% of senior executive compensation variable, PE firms often push this ratio higher to create stronger performance incentives. However, the art lies in striking the right balance – too little variable compensation may fail to drive desired behaviors, while too much can create excessive risk-taking.
The timing of incentives must align with the investment thesis and exit timeline. PE firms should consider creating balanced programs that drive both immediate operational improvements and sustainable value creation through a mix of annual bonus plans, strategic milestone incentives, and exit-based rewards.
Equity takes on special significance, often involving performance-vesting provisions and ownership ratchets that increase management’s stake as value creation targets are met. Unlike public company equity, these structures must carefully account for illiquidity and exit timing.
The balance between individual and group performance is also important. PE portfolio companies require exceptional teamwork to achieve ambitious value creation goals, yet also depend on individual leaders delivering specific improvements—and leaders’ compensation reflects that priority.
Making It Work
Effective PE compensation programs adapt these principles to specific situations. For example, in turnaround situations, programs might front-load incentives for quick wins in cash flow and operational efficiency while maintaining longer-term alignment through equity appreciation rights. Growth scenarios, by contrast, often demand rewards for both organic growth and successful M&A integration, with equity ratchets that increase management’s ownership stake as the platform scales.
Regardless of scenario, metrics must clearly link to value creation. While EBITDA improvement and cash flow generation remain cornerstone measures, PE firms often incorporate specific operational improvements and strategic milestones into their incentive programs.
Perhaps most importantly, compensation is a big differentiator in attracting and retaining top talent. In today’s competitive market, great executives have many options – from well-compensated public company roles to competing PE opportunities to entrepreneurial ventures. PE firms that get compensation design right gain a powerful advantage, creating the kind of compelling opportunities that make top executives want to bet their careers on PE-backed ventures.
About the Author
Tom Chinonis is a Managing Director at Townsend Search Group and specializes in representing private equity firms with C-suite placement across middle market and lower middle market platforms across the country. Tom works closely with management teams and investment professionals identifying key leadership for multi-national organizations across wide ranging industries, typically with locations that serve both domestic and global markets. Tom began his career as a corporate attorney specializing in mergers and acquisitions at an AmLaw Top 50 law firm, then served as the CEO in multiple start-up organizations before joining Townsend Search Group in 2021.
