13th
Private Equity Management Fees Under Attack
It was getting clearer and clearer that the famous 2%-20% fee structure of private equity firms was under siege. In particular the 2% side of the story, or the management fees calculated on committed capital, started to make investors uneasy, as fund sizes increased significantly in the 2001-2007 frenzy. LBO shops raising mega funds of several billion dollars were raking in tens of million in management fees alone, independent from actual investment performance.
Prequin cites a Wharton study of 2007 that suggested that buyout funds collected as twice as much in management fees (the 2% of committed capital) compared to the actual performance fees (the “carried interest” or “carry”, the 20% of capital gains realized when a company is divested through a trade sale or IPO):
Even before the LBO boom ended, firms earned almost twice as much from what they charged clients than from the gains they received from selling companies, according to a 2007 study by the Wharton School at the University of Pennsylvania.
LBO funds collect $10.35 of management compensation for every $100 they oversee, compared with the $5.41 they get from selling companies at a profit, according to the Wharton report.
It seems that the party is over. In 2009, institutional investors managed to negotiate a cut in the fee structure.
The 2 percent management fee that has been the industry benchmark for leveraged buyout funds since the 1970s is headed for extinction.
The California Public Employees’ Retirement System, the biggest U.S. public pension plan, AlpInvest Partners NV, Europe’s largest backer of private equity funds, and HarbourVest Partners LLC, which has more than $10 billion in LBO funds, are pressing firms to cut their rates.
And they are starting to get what they wanted:
The industry average stayed at about 2 percent until 2008, according to Preqin. Companies starting new funds this year are seeking an average management stipend of 1.8 percent. The figure is closer to 1.65 percent for offerings with more than $1 billion, Preqin reported.
All in all, I believe that this adjustment represent a realignment of incentives between general and limited partners that will benefit the industry in the long run.
