• Bonus and payout structures can create friction between sponsors and management when budgeting
  • Understanding sponsor expectations around risk appetite is key
  • Keep realistic and grounded in data while still driving for growth

In private equity, budgeting is always a balancing act.

Private equity demands strong, fast-paced, exit-focused performance. That often means setting lofty goals for growth during annual budgeting, when sponsors want to see rigorous goal-setting. Tensions can arise when management feels that sponsors are requiring unrealistic goals for the company’s size or timeframe — or when sponsors feel that management isn’t driving hard enough. 

Some amount of push and pull on budgeting is natural and healthy in order to maintain the balance between ambition and realism. Too much, however, can make meetings feel like a battle. But there are proven methods for creating better alignment that will both motivate teams and achieve the investment thesis’s goals.

When Budgets Undercut Alignment

Executive management is motivated to set attainable goals in order to realize bonus potential.  Sponsors, however, often see those goals as insufficient and potentially a signal that leadership is being passive in their goal-setting. Sponsors are aware that inflated SG&A leads to depressed EBITDA. Management knows that setting unrealistic goals can demotivate teams and negatively impact bonuses. As a result, too much time gets sunk into debates that could have been devoted to spearheading growth. 

Aggressive goal-setting may be desirable from a fund management standpoint, but it can cause problems when it comes time for executive bonuses to be awarded. Many PE-backed executives have their annual bonus structure tied directly to performance. In theory, this should create alignment between management and the sponsor. However, some bonus structures leave management in a position where they benefit from setting lower targets.

For more, see: Two Metrics That Rely on Integrated ...