Fee Structures - Non-Control Equity

Jack1inthebox

8% is market as it aligns with hurdle of the other control-focused funds that you would typically be investing with that are doing the managing. However, charging carry sort of goes against being a non-control equity participant as you are not in the drivers seat, thus not sure why someone would agree to compensate you with carry for not steering the ship, even with deep industry experience. Think your proceeds not being subject to carry and charging a fixed fee for your experience would be more likely.

Hmm, I've charged carry for a bunch of smaller deals.

I think the discount from market we are bringing the deals @ justifies it? 

For example, a co we are looking at might have $5m of EBITDA in a space where it would transact at 8x. We are able to buy at 5x b/c we are experienced operators and the company likes the idea of not having a 24 year old associate tell them what to do all day.

It's kind of wacky we wouldn't be rewarded for it unless I charge a huge fee? Also doesn't make sense bc minority equity like VC charges carry?

Your logic doesn't really track I guess?

lakakahakaka

Hurdle is fine but 30% carry is too high. Only brand-name VCs (Accel, Index) are charging that kind of fees and even out of that group only a select few have the performance to justify it (think consistent 4-5x net returns). A 2/20 structure is fine for minority growth equity -- some larger funds may charge lower fees and carry than that esp. if they have a more debt component to it, like a mezz piece + equity kicker. If you do have a very strong track record, 2/20 should be fine. European waterfall would be a plus

Name brand VCs are charging that with a fixed fee though? I mentioned no fixed fee above? I'd way rather skip the fee as it's easy for us to cash flow expenses with the existing portfolio.

Looking at Preqin & similar reports, it seems like LPs have a preference for more carry and lower fees with LMM size GPs?

What are you basing your thoughts on? Just trying to figure out exactly what data you're looking at.

I would second this. No one is paying 30% carry to an emerging manager or a mezz fund. 

Using a portfolio monitoring fee instead of a management fee doesn't change anything, most LP's will look at them the same way. 

dawgs.100

I think charging carry is fine but agree that 30% is probably too high but it's hard to say without a management fee. 8% hurdle seems market.

Caveat is that this is for deal-level carry, but I've seen 30% carry after meeting other hurdles (e.g., above 3x MOIC).  

Based on Preqin data, it seems like there's good give around carry without a fixed fee. Personally, it would appeal to me given the fee is a guaranteed loss and misaligns incentives.

Analyst 2 in AM - Other

My take: If you're so certain your IRR projections are directionally accurate and you want to charge above-market carry, then you should increase the hurdle. An 8% hurdle is nice for funds with mid/high teens carry; if you're positioning yourself as a high octane + high hit rate, you should be comfortable with a 12% hurdle. Second thought is that, as an investor, a carry % that starts with a 3 just sounds unpalatable. If I was approached with a high probability to 10x+ an investment over a short time period but was asked to give up 30%, I wouldn't think twice. But that number attached to a growth equity / buyout deal feels kinda icky. A tiered approach would look much more reasonable if you think there could be a couple moonshots. 

I like the idea of higher hurdle. I guess removing the fixed fee is kind of similar too, obviously not to the same extent. I am underwriting a ~10% - 12% hurdle.

Managing Director in PE - Other

It is always interesting to me that small or start-up firms are the ones trying to charge “super carry.” The industry has very much centered around 2/20 and there are many large firms that will discount the management fee for large commitments ($500 million+). 

If you can get 30%, that is awesome, but ask yourself, why would someone choose you over an established player at lower fees who can deliver similar returns. If you have a good answer to that question, then by all means go for it. The best argument is some strategies don’t scale and so you have more demand than supply.

You nailed it. 

Our core strategy + deal flow ATM I would not feel comfortable deploying over ~$150m - $200m max.

I believe we can recycle a ton as well given our focus on recouping cash in the first ~10 - 12 months.

At the end of the day, I can run the strategy with capital from my cofounder & I + existing LPs. It's enough to where we are comfortably netting quite a bit.

The real thing I am A/Bing this against is using fund leverage leverage to do deals and accelerate returns. So I need the $ from the fund to beat out simply using fund lvl leverage...

It sounds like appetite might be low so I'll just wait. I'm not really interested in this unless I can harvest good upside that reflects our track record. 

APAE

You aren't out of line, but you will get pushback from limited partners.

There are absolutely people getting 30% carry on the deal-by-deal model:

• I am in one (as an investor, not the manager).
• One of the first people I met in the independent sponsor world (I referenced him almost a decade ago in a comment on this site) was on a 1-and-30 on his fourth deal, same three family offices backing him for each one. I do not know if he started there or raised it over time.
• I achieved it myself once (however, we chose not to close on the asset after final diligence)

The guy going back and forth with you about control versus non-control does not make sense to me. Carry structures have nothing to do with which private equity sub-strategy you're practicing. I am working on a deal right now where I've invited a handful of lower/middle market sponsors to a non-banked look at a minority investment in a high-margin software business I own outright. All of them are well-known firms on funds ranging from second to sixth. Whoever wins gets 20-30% ownership, depending on valuation. All of them are charging 2-and-20 to their LPs, regardless of whether the deals in their fund are control or non-control.

You will get beat up a bit when trying to raise the money. A good portion will decline without telling you that they hated the fee structure. Some will do you the favor of being open about their dislike and try to negotiate it with you. The better your track record, the higher your GP commit, and the stronger the merits of the underlying deal (e.g. do you already have it under LOI and have robust diligence to evidentiate your value creation thesis), the more likely you are to get what you want. You just have to be willing to withstand the rejections, the scrutiny as they attempt to have you justify it, and the very likely delay it adds to your capital raise timeline.

In a way, it will mimic this thread. Most will say no outright, some will ask why, and one or two will spend the time to say 'it could make sense, let's see how'. My approach has always been that it only takes one. If you have to get told no ninety times before someone says yes to a thing that prints you unreasonable sums of money, was it worth it? Depends on your mindset. Pretty clear answer to me.

(Separately, note that skipping the management fee is actually a turn-off for a lot of people. It was eye-opening to me to learn many people would rather know you have guaranteed money available for team and expenses (that your personal balance sheet is not the only thing propping up the endeavor) rather than save a couple hundred grand on fee leakage. Later in my journey, I can see exactly how it makes sense. You think of it as incentive alignment, your investor is worried about the lights somehow going off.)

Good luck. 

Helpful - that's exactly where I'm at too. I don't get the fee pushback for being non-control, the logic used above was pretty dumb.

And RE: fees, we net more than enough to cover fixed fees off our existing portfolio + pay ourselves. That's why I want the upside. More fixed comp doesn't really change my life or stress.

I agree the whole control / minority debate is a red herring. OP said he has a lot of structure. You can have veto rights over any major decisions as a minority investor, which enables you to implement a private equity playbook. I’ve done both control and minority deals in my career, and I had the same level of involvement in both types of deals.