Family offices give staff stock, profit sharing in talent war

A version of this article first appeared in CNBC’s Inside Wealth newsletter, a weekly guide for high-net-worth investors and consumers by Robert Frank. sign up Get future editions delivered straight to your inbox.

As competition for talent intensifies, family offices are increasingly offering lucrative equity and trading interests to staff, according to top family office lawyers.

As family offices have exploded in size and number and compete more directly with private equity firms and venture funds for top talent, they have beefed up their compensation programs. In addition to salary and bonuses, many are offering stock grants and various forms of profit sharing to give employees additional benefits and incentives.

Family offices will have to adapt to a more competitive hiring environment, said Patrick McCully, a Chicago-based partner at McDermott Will & Emery LLP who represents single family offices.

“There’s a war for talent,” McCully said. “Family offices are competing with each other and with traditional private equity, hedge funds and venture capital for talent.”

Family offices, the private investment arms of single families, are also moving toward profit sharing as a way to better align staff incentives with family members.

“It helps get everyone rowing in the same direction,” McCully said.

Writing in the latest UBS Family Office Quarterly Report, McCully said there are three common ways single family offices compensate staff through transactions and equity plans.

1. Interest on profits

Profit sharing gives employees a share in the profits of a deal or series of deals. So if a family office buys a private company for $10 million and sells it for $15 million, employees might get $5 million in profits, or a share of profits above a target or “hurdle” (say, 5% or 6%). If there are no profits, employees get no share. “Basically, unless there’s growth, employees aren’t participating,” McCully said.

There’s also tax savings: Because the profits are capital gains, employees typically pay long-term capital gains tax rates of up to 20 percent rather than ordinary income tax rates, which can be as high as 37 percent.

2. Co-investment

Co-investing allows an employee or group to put their own money into an investment, essentially investing in the deal alongside a family member. Often the family member will lend the employee a portion of their funds for the investment. This is called a leveraged co-investment. That is, an employee may put $100,000 into an investment and borrow another $200,000 from a family member to get $300,000 in equity.

If the deal is not profitable, the employee may lose their investment and have to repay part of the loan. Family office owners like co-investing because it encourages employees to make less risky deals. They often combine co-investments with profit sharing to create both benefits and potential drawbacks for employees.

“Co-investments have drawbacks and may result in fewer risky ‘moonshot’ deals,” McCurry said.

3. Phantom Equity

If your family office is too complex, with dozens of trusts, partnerships and funds that make it difficult to issue profit sharing or co-investments, you may be able to offer phantom equity, which is a set of assets, funds or notional shares in a company that track performance without having actual ownership.

Phantom equity is like a 401(k) plan without the tax deferral, but it’s usually ultimately taxed at ordinary income rates, which can make it less appealing to employees.

“It’s not that common, but it’s mainly used for simplicity,” McCully said.

Because family offices cater to a single family, they have more flexibility than many corporations when it comes to designing compensation plans, but McCully said family offices that want to win the war for talent will need to start offering more forms of equity.

“There’s a crowd effect,” he says. “The more family offices start to offer, the higher the expectations of their employees. You don’t want to be the outcast when everyone down the street is offering.”

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