“BECOMING the chief executive of a big public company is the pinnacle of a business career.” As obvious as that statement might have appeared a few years ago, it would today meet with plenty of disagreement—at least from senior executives. These days they are under constant pressure to “meet the numbers” demanded by Wall Street analysts; ever-more demanding regulators burden them with paperwork; and who wants his pay and perks set out in excruciating detail in the annual report, bringing the almost inevitable accusation of being a fat cat? Faced with all that, no wonder some executives opt for a quieter—and more lucrative—life in the rich pastures of private equity.

The basics of a successful private-equity deal are well established. Borrow a lot of money and buy a public company or a neglected division of a company. Cut costs, increase profits, pay back debt and, after a decent—but not too long—interval, take the company public again, by selling its shares. As easy as it sounds, this takes grit and hard work. Hence, the need to “incentivise” managers by giving them the chance to make a fortune.

A fortune is certainly for the having. Take SunGard Data Systems. In August 2005 the Pennsylvania-based software provider sold itself to a private-equity syndicate for $11.4 billion, and then delisted its shares from the New York Stock Exchange. Its top executives got three windfalls. First was the “accelerated vesting” of share options. Thanks to a change of control, managers could take profits from the premium paid by the buyer straight away rather than going through the agonising wait for options to mature (and enduring the risk that the share price could fall in that time). Second, the managers of the acquired business—largely the same team that was in place before

the deal—got new options on 14% of the company's equity, albeit with performance hurdles attached. Finally they were allowed to buy shares in the new company, with a good prospect that they would increase in value, as the newly acquired debt was paid off.

SunGard's chief executive, Cristóbal Conde, did very well. Together with his family he owned shares worth $17m at the takeover price; on top of this, he made paper gains of $58m from existing stock options when the company was bought. He was then given a new option grant for continuing in the job after the buy-out, worth around $44m. The total return of close to $120m amounts to 1% of the firm's value—not unusual for chief executives in deals of such a size.

When a company is resold or floated, there is usually more money to be made. One recent example comes from Britain, where managers' windfalls are usually less lavish than those across the Atlantic. The chairman of QinetiQ, Sir John Chisholm and Graham Love, the chief executive, together own 3.6% of the defence-technology firm. They bought the holding for an estimated £240,000 in 2003 when the Carlyle Group, a large private-equity firm, acquired control. On the company's flotation in February, the two directors made paper gains of £47m ($82m).

Nor are these kinds of gains from private equity confined to the “Anglo-Saxon” economies. On February 21st Legrand, a French maker of electrical equipment that has Kohlberg Kravis Roberts and Wendel Investissement, two private-equity firms, as its biggest shareholders, filed its prospectus ahead of a possible April flotation. Of the €7 billion ($8.4 billion) that the shares are thought to be worth, the company's top 200 managers own around 5%, or €350m ($420m). If precedent is anything to go by, a large part of this wealth will be concentrated in the hands of the 12-strong executive committee.

These handsome returns will buy a few country estates, leaving plenty of change for the odd yacht. According to one recruiter who draws senior managers into private-equity-backed companies, the “basic” expectation is to make a capital gain of around $10m within five years. Barring a sharp change in sentiment in the credit markets that give private-equity investors their buying power—or in the stockmarkets that provide them with an exit—the stakes will be raised in 2006, as will the competition to hire talented managers. With a record €120 billion ($150 billion) in buy-outs in Europe in 2005, competition among private-equity funds for suitable businesses is now more intense than ever. As buyers pay more for them and load more debt on to their acquisitions, so the deals get riskier—and getting the right management team matters more.

That in turn means public companies are having to fight harder—and pay more—to keep their top managers. Marks & Spencer, a big British retailer and a veteran of frenetic corporate activity, rebuffed a takeover bid in 2004, prompting an overhaul of its management team. The following year, the board put a new pay structure in place. Now, the top five executives stand to get cash and share awards each year of up to two or three times their salaries. For Stuart Rose, the chief executive, this means a possible payout of close to £10m ($17m) over the next five years, as long as profits at least double.

Not all M&S shareholders were happy: 18%, a high proportion by the gentlemanly standards of AGMs, voted against the pay awards. Since the contested pay deal, though, investors have had few grounds for complaint. M&S shares have risen by 68%. Yet Mr Rose is unlikely to make the sort of gain he could in private equity, and he may pay more tax than he would if he had quietly accumulated capital in a private business.

Private equity is not for everyone. Some may find the young (and not so young) thrusters who run funds too demanding to work for, especially if they have not realised big gains after five years. And a paper from the Centre for Management Buy-Out Research at Nottingham University points out an important fact that is often buried in the eye-catching pay data—close to one-third of British private-equity-backed businesses go bust.

 

Mar 16th 2006