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A version of this article first appeared in CNBC’s Inside Wealth with Robert Frank newsletter, a weekly guide for wealthy investors and consumers. Register to receive the next editions, directly in your mailbox.
Family offices are increasingly offering lucrative stock and deal benefits to their staff amid a growing battle for talent, according to a leading family office lawyer.
Family offices, which are proliferating and increasingly competing with private equity and venture capital funds for top talent, are increasingly adding to their compensation packages. In addition to salaries and bonuses, many now offer equity investments and various forms of profit sharing to give employees more opportunities and incentives.
Patrick McCurry, a partner at Chicago-based McDermott Will & Emery LLP who works with family offices, said family offices must adapt to a more competitive recruiting landscape.
“There’s a war for talent,” McCurry said. “Family offices are competing with each other and with traditional private equity, hedge funds and venture capital.”
Family offices, the private investment arms of individual families, are also turning to profit sharing to better align staff incentives with those of the family.
“It helps everyone row in the same direction,” McCurry said.
In an article in the latest UBS Family Office Quarterly, McCurry said there are three common ways family offices pay their staff through transaction and equity plans.
1. Interest on profits
A profit share gives an employee a share of the profits from a deal or basket of deals. So if the family office buys a private company for $10 million and sells it for $15 million, the employee might get a share (say 5% or 6%) of the $5 million profit, or the profit above a target or “threshold.” If there is no profit, the employee gets no share. “They basically don’t participate unless there is growth,” McCurry said.
They also save on taxes. Because the profit is a capital gain, the employee typically pays the long-term capital gains rate (which tops out at 20%) rather than the ordinary income rate, which can be as high as 37%.
2. Co-invest
A co-investment allows an employee or group to invest their own money in an investment, effectively investing in a business alongside the family. Often, the family will lend the employee some of the money for the investment, which is called a leveraged co-investment. For example, an employee could invest $100,000 in an investment, borrow an additional $200,000 from the family, and get a $300,000 equity stake.
If the deals don’t generate a profit, the employee loses his or her investment and potentially has to repay part of the loan. Family office owners like co-investments because they encourage employees to take on less risky deals. They often pair co-investments with profit sharing to create both upsides and potential downsides for staff.
“With co-investments, you have a downside, which allows you to do fewer ‘moonshot’ deals that would be high risk,” McCurry said.
3. Phantom equity
If a family office is too complicated, with dozens of trusts, partnerships and funds that make it difficult to issue beneficial shares or co-investments, it may sometimes offer phantom shares – notional shares of a basket of assets or a fund or company that track performance without actual ownership.
Phantom equity can be thought of as a tax-deferred 401(k) plan. But it typically ends up being taxed at ordinary income tax rates, which can make it less attractive to the employee.
“It’s not as common, but it’s mainly used for simplicity,” McCurry said.
Because they serve a single family, family offices have more flexibility than most businesses when it comes to designing compensation plans. Still, McCurry said family offices that want to compete for talent need to start offering more forms of participation.
“There’s a crowd effect,” he explained. “The more family offices offer this service, the more employees expect it. You don’t want to be an isolated case when everyone else is offering it across the street.”
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