Paying for carry at fund
Just joined a secondaries fund and was given the option to subscribe for carried interest at the fund. However, I would need to finance this myself.
Was wondering if: (a) Do you all pay for the carry at your fund? Wanted to see if this was market practice. (b) If not, do you invest the maximum that the fund allows you to subscribe? Given that this is a secondaries fund obviously the expected returns wouldn't be as attractive as a direct fund and so I am think of subscribing for less than what I entitled to. Also, I feel that there are better places I can park my money and would consider not subscribing at all.
Thank you.
a) Yes its standard to have an LP Commitment attached to GP carry. If the GP is in for a $10M commitment and you get 2% of the carry, then you have to fund a $200K LP Commitment.
b) I'm not sure why you wouldn't do the maximum allowed? Unless your fund's historical returns aren't any good, even a downside case of 6% gross is a pretty good return on your LP Commitment. Also, while the multiple won't match a direct fund, the IRR should be very good, ~15% range. Where else are you getting that kind of return?
I think it would look pretty weird if you decided not to participate in the carry to be honest.
1) You should be getting this commitment on a no fee/carry basis. So what the gross returns are, that's what you get. Again, I'm not sure you'd be getting better risk adjusted returns anywhere else.
2) That's a valid point. But I think if you left before the investment period was over then the firm would buy you out at cost.
I'm surprised any firm is giving carry at those levels, mainly for the issue you've raised, that its unlikely you'd stay that long. So I'd say ~0 to .5%.
Like the other gents pointed out, it is standard to effectively "buy in" to the capital commitment. You will be on the hook for your piece, but the cash might not always come out of your pocket.
For example, if you are buying a piece of an adviser company that owns a portion of the GP, the adviser company also earns a 2% mgmt fee. That fee usually covers overheads, salaries, and hopefully has some left over. That adviser company could pay for the GP commitment, rather than distributing the profit in bonuses or dividends which you would have to pay tax on, and then call cash later for an investment. If all the investments happen early in an investment period, there probably won't be enough profits in the adviser entity and there will be a cash call up to your %.
When it comes to returns, start doing the math. Carry adds up fast. See what you would get at a fund net 1.5x, 2x, etc from the carry piece. Also, when was the fund raised and when do they expect to distrubute? If you're joining mid-fund there's probably good IRR.
I always thought "carry" was typically with no out-of-pocket, after all it's a form of compensation (though I could be very wrong here).
Once you pay for carry, isn't it basically just "co-invest"? I know co-invest is more common at a junior level. Some other friends & I are all offered "unlimited" co-invest on a no-fee basis, though I imagine it might get interesting if some associate had millions to put in.
If you want to think of it like co-invest, it's like co-invest with very juiced returns to the upside.
Using rough numbers: $5B fund, including a $250M GP capital commitment. You are given 0.1% of the carry pool, and have to "buy in" 0.1% of the GP capital commitment, or $250k.
The fund makes a 2.0x return and is a standard 2/20 that is over the hurdle rate.
Your pre-tax return is ($250k * 2.0x ROI) + ($5B * (2.0x - 1.0x) * 20% carry * 0.1% ownership) = $1.5M.
Therefore, if you think of it as co-invest, you made 6.0x ROI when the fund made 2.0x.
Exactly. Its 2 different streams of distributions, 1 you pay for (LP commitment), the other you don't (carry).
Want to post to dispel a lot of misinformation and highlight petergibbons and @m8" as people who know what they are talking about.
In most fund vintages (e.g. "Iconic Southwest-American Tree Fund X, L.P.", or "Geologically-themed Gobbledygook Fund II, L.P." ) there is a vintage-specific GP entity which commits alongside the LPs of the fund. So, if that fund raises $5B in LP commitments, the GP is obligated by the fund documents to put up 5% let's say, or $250m.
This commitment is made by a vehicle which both has managerial control of the fund from a legal perspective and also has a partnership stake in the fund as well. As a junior employee, you are likely to be given the opportunity to purchase a piece of the pie on the GP commitment **only **- meaning that of the $250mm committed by the GP and its employees, you will be entitled to invest up to some amount that is predetermined by your employment agreements - likely 0-0.05% as a junior employee. So, if you invest that 0.05%, you will have skin in the game in the fund you are managing, and you will be entitled to 0.05% of the returns that the 250M sees, and you probably won't be charged mgmt fees on the profits.
This is entirely different from owning a stake in the "carry", which means that you are entitled to a profit share in the management company. Typically shared ownership of the management co is open only to longtime, senior-level employees and partners/founders. This entity is the one that is accruing the 20% hurdle profits if your fund does well, and that 20% is not based upon any form of "skin in the game".
On a separate note, OP, I would strongly recommend that you never disclose the fact that you have more faith in the ability of crypto markets to deliver profits than the investment services you are providing at your fund. Your employers' reaction will at best be "what the fuck", if this comes to light.