What Are You Smoking?

Andy Lee
4 min readDec 3, 2021


It’s that time of year again, where many prepare for annual reviews / bonus season. It’s been a record year for many. This Thanksgiving, I’m sure a number of you will be scrutinizing / detailing every project you’ve worked on in hopes of justifying that desired bonus number. I’ve had a number of outreaches in that regard as friends try to utilize me as a sounding board in preparation for those year-end discussions

This perspective is a single point of view and trying to frame how someone in my seat MIGHT think about bonuses. From my seat running a firm, the most important advice I might give is:

Know Thy Audience: What matters to the individual seated across from you?

i) Understand how that individual gets paid

ii) Know how you create economic value for that individual

iii) Understand the resources (risk / reward) that the individual has

Some ground rules to frame the discussion:

I urge you to think about your firm’s business model with the same zeal you apply to analyzing businesses

You need to be expected, over time, to deliver more value than you extract (in compensation)

You are NOT 100% incremental margin [if you are — please email me, I have a job for you], there are cost associated with you being part of the firm in the form of middle / back office and God forbid Analysts / Associates / VPs who enable you to do your job

Your firm deserves to earn a margin (best in class FRE margins are in the 50% zip code) on your efforts. Imagine running a business where you’re allocating capital and receiving no return on that capital. Your firm is NOT just allocating fund capital, it is also allocating time / capital at the MGMTCo and deserves to earn a margin [otherwise, why are they even in business?]

So here are a few items I’ve extracted from my conversations:

1) Not many realize how the business of alternative asset management works; think about the economic model of your firm

(a) “If I deploy $10mm of capital earning 10%, that easily pays for me [assuming $1mm cost]”: Credit Hedge Fund Investor

That likely is true if your employer was utilizing its balance sheet, however that likely is fund capital so the house is earning [assuming 1% MGMT Fee / 20% Carry] or specifically $100K of MGMT Fee and $180K of Carried Interest or $280K in aggregate. Your firm just absorbed a loss of over $620K for you to be gainfully employed

To the extent your firm utilizes leverage, then the fee base could be commensurately smaller

(b) “I’m cheap [$750+K] relative to what I can get in the market”: Private Equity Investor

That might well be the case, but if your firm has NOT deployed meaningful capital this year, you’re likely creating a large J-Curve [if still in the investment period] or living off fees on invested capital / NAV (typically 1%)

In which case, I hope you’re (by yourself) doing asset management on $150+mm ($750K / 1% Fee / 50% FRE Margin) of equity capital

(c) “I’m expecting a huge bonus as we were able to exit / refinance out of our portfolio”: Private Credit Investor

I’m NOT sure that’s right… Most private credit vehicles are paid fees off invested capital. If you were re-financed out of your names, you have no outstanding invested capital at work which means no ongoing fees

You might be in receipt of carried interest but knowing private credit’s MOIC profile of 1.2x — 1.3x that’s unlikely (and will likely be entirely ordinary income). Good luck eating IRR… IRR is an important measure, but it is NOT the only measure that’s important

2) Are you absolutely certain this is a growth platform for the firm?

(a) “We’re going to raise a BDC / Credit Platform then spin out”: Private Credit Investor

If that’s the upside case, let’s size the prize — $250mm Equity / $250mm Debt for $500mm of Total Capital

BDCs typically have RoAs of 8+% so on $500mm of capital that would be $40mm

The Cost of Funds for theoretical purposes, let’s make it 4% or $10mm ($250mm x 4%)

The Return on Equity (pre-fees) would be $30mm ($40mm — $10mm)

BDCs charge Asset MGMT Fees on 1% of Assets so $5mm ($500mm x 1%)

BDCs also charge Incentive Fees of 20% (at the very high end) so on $25mm of profits ($30mm — $5mm) would be $5mm of Incentive Fees

So in total $500mm of Assets (not assuming any loan losses or cash drag — likely generous), you would generate $10mm of total Fees (or Revenue)

I’ll leave it to you to solve the cost structure requisite to ensure that the BDC trades at par (remember that RoE in my example would be $20mm [$30mm — $5mm — $5mm] or 8%)

If you ran an Alternative Asset Manager with $250mm lying around, would you really build a business to generate $10mm of revenues and $20mm of P&L?

A kind soul reminded me that BDCs are now allowed 2:1 leverage albeit I’m not sure that incremental leverage necessarily changes my point of view on the above

(b) “We’re going to scale this platform”: Private Credit Investor

Private credit as an asset class continues to grow and unless you’re Apollo and able to source / place 5% paper with an Athene, you’re likely in 8+% land where capital formation has been extreme and supply has NOT kept up. The asset class is likely to be mid-teens grower from here

To be part of a young business ($1bn) that scales (i.e., 10x in 10 years or 26% CAGR) with an asset class with a three year weighted average life would mean the firm would need to originate $21bn of new assets

The number of bodies (i.e., cost) to achieve that outcome is staggering

So all that being said, I would urge you to put this year behind you. The number is essentially baked. Look forward to next year and ask the question, “how can I stuff so many dollars in my firm’s pocket that it overflows with me as a recipient“



Andy Lee

Just a little country boy, lost in the city. Property of @tacoboutcorgi Get in touch via andy@parallaxescapital.com