Helge Tveit, managing partner at EV Private Equity, has been considering for some time how best to tie impact performance to carry. “It creates alignment and demonstrates your intentionality around creating impact,” he says. “It goes far beyond just saying you are working towards an impact goal – that is very fungible.”
Yet devising a set of metrics that is both credible and quantifiable is not an easy task, even for a firm focusing on technology that reduces greenhouse gas emissions. “Initially, we wanted to include pollution and we looked at whether we could design a matrix that included both pollution and CO2 reduction,” Tveit says. “But we concluded that we needed clarity and specificity around what we were seeking to achieve. There is a straightforward scientific basis for measuring CO2; there isn’t for pollution.”
The firm has opted for a carry-at-risk structure with targets that consider CO2 avoided but also how much portfolio companies contribute to greenhouse gases.
It has also opted to buy carbon credits with carry forfeited in the event the fund does not achieve its target. “We wanted to defuse the difference in incentives between LPs and GPs if we can’t achieve our targets,” says Tveit. “This way, LPs still get the same financially, while also achieving an impact on their net zero goals.”
The alternative view
Palatine Private Equity has opted for a different route for its impact fund. It donates 10 percent of carry earned from the fund to a charitable foundation – an arrangement the firm expects to continue for subsequent funds, says partner Beth Houghton. “There’s a lot of complexity around setting targets for our portfolio,” she says. “We recognise that we are still learning how to set them, so they are stretching but also realistic. We don’t want to be setting soft targets – we want to really drive impact performance.”
The firm takes the view that the consequence of not achieving impact and returns is already built into the private equity model. “If investors are not happy with our performance on impact or financially, we won’t raise our next fund,” says Houghton. “That is a far bigger financial penalty than forgoing a percentage of carried interest – especially when not all funds reach carry anyway.”
However, Houghton is watching developments with curiosity. “We may never know what happens since carry is not publicly announced,” she says. “But it would be interesting to see if funds implementing this always hit their targets.”