How To Understand The Financial Structure Of A Hedge Fund



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Glbal Prime Finance Hedge Fund Cnsulting Grup Hedge Fund Cmpensatin Trends and Deferred Cmpensatin Plans fr US Funds Ntes frm DB Glbal Prime Finance Cnsulting Dinners Chicag / Dallas July 2011 General HF Cmpensatin Trends: 2011 is a rbust and cmpetitive envirnment. Gd candidates can ptentially see multiple ffers tday. Partner level and senir emplyee level ttal cmpensatin is generally flat year ver year. Deferred cmp becming mre cmmn at HFs. Typical scheme: 3 year straight line vesting perid, affected cmpensatin minimum befre vesting takes effect: $200 500k. Deferred is typically reinvested back int the funds when pssible. True equity (i.e., actual wnership in GP with vting rights and payut in the event f a change f cntrl) is much rarer tday fr all but the funder(s). Phantm equity (r prfit payut) is mre cmmn which prvides x% f prfits frm the incentive fee but des nt include a payut in the event f a change r cntrl r require a buyback, r future prfit payments, in the event that the emplyee leaves. The nly place we see true equity awards are with startups fr very senir hires. Guarantees Less cmmn in 2011. Base salaries Flat fr senir emplyees. Rising fr mre junir emplyees a result f rising bases at banks + brker dealers. Reginal cmpensatin Little t n reginal difference fr mid senir level peple. Junir level peple especially back ffice persnnel, wh are hired lcally, can be significantly less expensive (30 50% cheaper) than NY (e.g., Ops, Accunting). Marketers ( asset gatherers NOT just investr relatins) Has had the mst grwth in cmpensatin ver the past cuple f years with 15 20% increase in cmpensatin YOY. Dug Kline 1

Glbal Prime Finance Hedge Fund Cnsulting Grup Hedge Fund Cmpensatin Trends and Deferred Cmpensatin Plans fr US Funds Thse with 10+ years in this rle are very hard t cme by and demand a significant premium ver their less experienced cmpetitrs. Cmpensatin is less frmulaic tday and mre base + bnus in terms f structure. But bnuses will be driven by amunt f assets gathered. Typical base: $150k $250k. Typical ttal cmp at a mid size fund: 1 st year $600 800k, typical 1 st year ttal cmp at a large / tp tier fund can easily tp $1mln. Chief Cmpliance Offers (CCOs) The ht HF jb nw. Demand being driven by SEC registratin requirements. Mre candidates with Law degrees and SEC experience in the mix vs. prir years. Starting cmp range fr 1 st year fr mid t larger size fund is $250k $1mln+. Median is ver $500k. Deferred cmp less cmmn fr CCOs as cmpensatin in the fund can be seen as a cnflict. COO / CFOs Cmp has been mstly flat last cuple f years. Gd supply f candidates nw. Traditinally, biggest surce f these candidates was frm Big 4 accunting firms. Mre candidates frm ther backgrunds mre cmmn tday. Characteristics that determine HF candidate cmpensatin levels: Previus HF experience. Fund Size / Perfrmance. Pedigree (CPA, CFA, schl etc.). Dug Kline 2

Deferred Cmpensatin: Definitins: Deutsche Bank Glbal Prime Finance Hedge Fund Cnsulting Grup Hedge Fund Cmpensatin Trends and Deferred Cmpensatin Plans fr US Funds Internal Revenue Cde: 409 A (prnunced 4 0 9 Cap A). Effective 1/1/05, mainly in respnse t Enrn situatin where executives accelerated their deferred cmp payments while rank and file emplyees culdn t and als t address perceived tax timing abuses. Intended fr crpratins and partnerships. Deferred cmp isn t taxed until paid. Hlding deferred cmpensatin balances in ffshre funds typical fr HFs. Internal Revenue Cde 457A Effective Jan 1 2009, intended fr HF and PE partnerships. Part f the Emergency Ecnmic Stability Act f 2008. Gal: remve tax deferral benefit t partnerships fr ffshre deferred cmp plans (and make these mnies subject t immediate taxatin). Offshre fund cmpensatin deferral fr incentive fee structure nw gne. Any vilatins trigger immediate taxatin and penalties f 20%. There is immediate tax liability even n deferred cmp, manager deductins nly when deferred cmp is paid ut. HFs can change structures r use ther methdlgies t defer cmpensatin and require emplyees t keep mney in the funds: Emplyment agreements requiring certain cmpensatin amunts t be held in the fund fr a perid f time (tax benefit r deferral is lst under 457a but emplyees still have skin in the game by having mney in their fund). Emplyee fund investrs need t be: Knwledgeable emplyees (KEs) r Qualified Purchaser (QP) fr 3c7 funds / Accredited Investr (AI) fr 3c1 funds. Dug Kline 3

Glbal Prime Finance Hedge Fund Cnsulting Grup Hedge Fund Cmpensatin Trends and Deferred Cmpensatin Plans fr US Funds This is prblematic fr emplyees wh dn t meet abve standards. There are sme cmplex structures that can be created t serve the emplyees wh dn t meet these standards, but fr mst funds it s nt wrth the cst/effrt t establish these entities fr nn qualified emplyees. Sme managers shut dwn ffshre deferred cmpensatin plans fr anther reasn entirely the likelihd that future tax rates may be higher than current tax rates. There is a philsphy that exists at a small number HFs tday where there is 100% cash cmpensatin with n deferrals / hld backs. This philsphy is based n the fllwing: A deferral prgram will actually cause valued emplyees t leave earlier than they therwise wuld. Especially fr senir analysts / PMs, they dn t want t get t highly deferred s they will leave an rganizatin befre they therwise wuld t start their wn fund. we want emplyees wh want t be here fr mre than just the mney. if an emplyee came here fr just the mney they will leave us fr just the mney. Carrt apprach is mre effective than stick in affecting emplyee retentin. Cmpensatin deferral plans are viewed as a stick Speakers: Bridget O Neill, Partner, Sidley Austin bneill@sidley.cm, (312) 853 2205 Valerie Valtz, Senir Vice President, GlCap Search valtzedis@glcap.cm, 646 964 6220 DB Hedge Fund Cnsulting: Dug Kline, Managing Directr, dug.kline@db.cm, 212 250 2700 DB Glbal Prime Finance Sales: Sctt Carter, Managing Directr, sctt.carter@db.cm, 212 250 4950 Peter Alpern, Directr, peter.alpern@db.cm, 212 250 4950 Jeff Knupp, Directr, jeff.knupp@db.cm, 312 537 3759 Dug Kline 4

Glbal Prime Finance Hedge Fund Cnsulting Grup Hedge Fund Cmpensatin Trends and Deferred Cmpensatin Plans fr US Funds DISCLAIMER: The infrmatin cntained in this material is fr discussin purpses nly. It is nt an ffer, r slicitatin f an ffer, t buy r sell any security r financial instrument r t participate in any trading strategy, r a slicitatin r recmmendatin f any f the service prviders, advisers r vendrs referenced herein, and such material is t be used in cnjunctin with any infrmatin and advice yu may receive frm said service prviders, advisers and/r vendrs. Assumptins, estimates, views and pinins expressed herein are thse f Deutsche Bank s Hedge Fund Cnsulting Grup as f the date f this publicatin and are subject t change withut ntice. The material is based n infrmatin frm surces believed by Deutsche Bank t be reliable. Althugh the infrmatin herein has been btained frm surces believed t be reliable, we d nt guarantee its accuracy, cmpleteness r fairness. Opinins and estimates may be changed withut ntice and invlve a number f assumptins which may nt prve valid. Deutsche Bank r persns assciated with Deutsche Bank, may, frm time t time, maintain relatinships and/r engage in transactins with the third party vendrs and service prviders referenced herein. The infrmatin cntained in this material is prvided n the basis that it is intended slely fr yur wn internal use, and n the basis that yu have such knwledge and experience in financial and business matters t be capable f evaluating the merits and risks assciated with such infrmatin. While, in its prvisin f hedge fund cnsulting services, Deutsche Bank may ffer industry expertise and guidance, yu (using yur wn independent advisers as yu deem necessary) bear ultimate respnsibility fr the decisins made with respect t the services cntemplated herein based upn yur particular gals and bjectives. Certain risks assciated with hedge funds investments include, but are nt limited t, the fact that hedge funds: can be highly illiquid; are nt required t prvide peridic pricing r valuatin infrmatin t investrs; may invlve cmplex tax structures and delays in distributing imprtant tax infrmatin; are nt subject t the same regulatry requirements as mutual funds; ften charge higher fees and the high fees may ffset the fund s trading prfits; may have a limited perating histry; can have perfrmance that is vlatile; may have a fund manager wh has ttal trading authrity ver the fund and the use f a single adviser applying generally similar trading prgrams culd mean a lack f diversificatin, and cnsequentially, higher risk; may nt have a secndary market fr an investr s interest in the fund and nne may be expected t develp; may have restrictins n transferring interests in the fund; and may trade a substantial prtin f their trades n freign exchanges. Deutsche Bank means Deutsche Bank AG, its branches and affiliated cmpanies as the cntext requires. Deutsche Bank AG, including its subsidiaries and affiliates, des nt prvide legal, tax r accunting advice. This cmmunicatin was prepared slely in cnnectin with the prmtin r marketing, t the extent permitted by applicable law, f the matters addressed herein, and was nt intended r written t be used, and cannt be used r relied upn, by any taxpayer fr purpses f aviding any U.S. federal tax penalties. The recipient f this cmmunicatin shuld seek advice frm an independent tax advisr regarding any tax matters addressed herein based n its particular circumstances. www.db.cm Dug Kline 5