Case: Martin Smith: January 2002

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Private Equity: Leveraged
Intro Case:
Martin Smith

Martin Smith—Case Objectives
• Examine components of PE compensation and
their relative weight
– Case Exhibit 4 (difference between Salary and Total is
Carried Interest)

• Evaluate difference between IRR and
Multiple on Investment (two return metrics)
– Case Exhibit 6

• Begin to explore differences among funds as an
employee and investor
– trade-offs include compensation, track record, strategy, focus, reputation, risk, sustainability, etc.

Martin Smith
• Multiple offers: Nice dilemma!
– Excellent background for PE

Economics background
Banking experience
Financial operating experience

Martin Smith, cont’d
• Effective job search strategy:
– Target groups that match background
• Avoiding VC, where engineering and longer term
operating experience is more highly valued

– Focus on more credible groups
• As opposed to first-time funds—Avery search fund

– Extensive research
• Lots of (too much?) due diligence

Martin’s Dilemma
• Differences between firms/funds:
– Brand name/reputation
– Background of partners
– Deal flow strategy
– Industry focus/investment strategy
– Investment track record
– Organizational structure (number of partners,
offices, etc.)
– Capital under management: today and growth of
funds in the future

Martin’s Dilemma
Differences between firms/funds, cont’d
• Track record:
– Multiple of money invested
– Realized vs. Unrealized
– Vs. Benchmark
– Within Vintage
– Consistency
– Longevity

Martin’s Dilemma, cont’d
• Differences in compensation
– Current base salary
– Bonus potential
– Opportunity to share in carried interest
• now and in the future

– Division of carried interest and management fee
among partners (and others)
– Opportunity for co-investment
• firm loans to co-invest?

Martin’s Dilemma, cont’d
• Building personal reputation in “brand name”
firm early in career may be useful
– Creates pull away from search fund

• Is it easier to move from one firm to another
later (e.g., is it easier to move from a search
fund to Newport, or vice-versa)?

Newport Partners
• Highest current compensation
• Potential for carried interest
• $1.2 B managed by only 12 people—more
responsibility, less dilution of economics
• Has the “brand” suffered?
– “Bad” diversions into tech/telecom and international – “back-to-basics” may resonate with investors, match skills of firm

• Implications of track record:
– Future returns? Ability to raise more funds?

• Succession issue? Culture after many departures?
No history of promoting from within?
• Can you start here, and “trade down”?

Knowledge Capital Partners
• Lower starting comp than Newport, better than Search
• Won’t discuss carry
– Implications for interest in developing “real partners” down the road?

• $1 B managed by 38 people
– Still a small firm, but Martin getting to be one of a crowd? – Better opportunity to find a mentor?

• Specialized strategy: spin-offs
– Conflicts with (“stealing” from) consulting clients? – Sustainability of strategy?

• Ability to manage growth: fund growth = 5 X
– Implications for strategy and personnel

• Firm could spit with consulting firm
– Implications for strategy, deal flow, recruiting?

Search Fund—Steve Avery
• Lowest starting comp
• 2 people split ALL the carried interest, but
– Will there be any?

• What if entrepreneurs don’t fund the deal?
– Capital not as committed as institutional funds

Credibility with sellers of companies?
Ability to raise debt financing to close acquisition?
Culture: better get along with Avery
Outcome more highly dependent on skills of Avery and
Martin; no mentors
• Outcome quite binary—win/lose
• LONG run success could be HUGE—senior partners the
next Henry Kravis and George Roberts?

Ideal background for Private Equity?

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