Why 1099 Self-Employment Contracts?

Becoming an Operating Partner (OP) is an enticing prospect for many PE-backed CEOs looking for their next opportunity. OP roles at PE firms promise increased financial gain both through higher base salaries as well as carried interest and equity from portfolio companies. In addition to the economic upside, an OP role means having a direct impact on the performance and growth of portfolio companies. 

Executives seriously considering this role, however, are increasingly encountering a new compensation structure: 1099 contracts. There are several reasons why more firms are choosing to employ OPs through 1099 contracts that have nothing to do with a lack of commitment to the operating partner — and actually include multiple benefits for the OP.

MYTH: “The fund is paying me contractually because they aren’t invested in me.”

FACT: Yes, 1099 contracts lack traditional employee benefits such as 401k contributions, health insurance, severance, and other similar perks tenured employees enjoy. Counterbalancing this, however, is the fact that 1099 contractors tend to make more both in base salary and equity payouts than their W-2 counterparts at similar-sized firms.

Still, why structure payment this way? The answer lies in the distribution of funds that firms can give to their employees. Most if not all PE firms follow the “2 and 20 rule” — meaning that 20% of carried interest from portfolio companies becomes income for the firm, and around 2% of all committed capital is devoted to management salaries. Given that PE firms manage billions of dollars...