Breaking down Annual Comp of a PE Partner

How accurate is this simplified annual comp breakdown of a MM PE Partner that makes over $5 million in a tier-2 city and is investing out of two funds - $250MM Fund II and $500MM Fund III (assuming both funds return 2x gross in 5 years).

Does a MM PE Partner actually make 75% of his/her comp in the form of carried interest/income from GP committed funds (taxed at LTCG)? Does a PE Partner pay just 22% in taxes (as a % of total comp)?

Check out my calculations for total compensation both (pre-tax and net earnings) broken down in the google sheet below-

MM PE Partner Comp Google Sheet

Feel free to discuss below and add comments to the google sheet so I can make adjustments.

 

I mean yeah that’s basically it- the firm aims for a certain MOIC and gets “20%” of excess generated. From that the partner gets their carry.

A 500M fund with 2-3x MOIC returns 1000-1500M. with carry of 20% the firm gets 20% of 500-1000M excess generated which comes out to 100-200M.

in this case 12.5% would be 12.5-25MM which is dat good good. Numbers could be all over the place though. typically carry is treated as capital gains (I think) and there are smarter people than me out there that can probably structure it as such as any GP/LP commitment would have.

I have no comment on employee only funds, GP only committed funds (who together has 500M let me know so I can pay them a visit). I think funds typically have senior / employee commitment around 12.5% total with MM funds (at least is the case for Audax) from what I’ve seen. I haven’t added much to this discussion on anything complicated but you’re on the right track. I could be wrong for your more specific questions.

 

PE fund life is ~10 years typically not 5... Investment period is typically 5 years and divestment is also typically 5 years. You don't really start seeing any carry distributions whatsoever in the first few years of a fund's life.

In other words this whole model doesn't make sense structurally and your $5M number is completely off. More realistically the partner would only properly start getting carry cheques at some point in late 2020 or early 2021 whilst mostly being actually paid cash comp whilst vesting into their carry allocation.

 

My guy I summered at a PE FoF and and have built investment summaries for over 50 PE funds - I know 5-year funds rarely exist (I work at a MM PE firm...) but I tried to keep it fund structure simple to make calculations easy. To answer your earlier question, 3-year investment periods and 7-year fund life are somewhat more common than you realize especially in industries like GE so I adjusted the calculations to account for this and added a waterfall distribution for carry that starts paying in year 3. Don't just criticize the structure of the model and say numbers are completely off, I started this discussion so people could share insights and add value to the GP comp discussion. The end goal was to understand how much of the comp does carry form and what the average tax rate for a PE GP is.

 
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I know your illustration was meant to be simple, but you need to realize that very few GPs ever invest 100% of the committed capital. You need to reserve capital for fees and portfolio support. Probably safer to assume you invest 80% of the fund, you draw 10% for fees, and you use 10% for portfolio company reserves that may never be called and for dead deal fees since you aren't going to close 100% of the deals you look at. That means that a $500M fund may only invest $400M and return $800M gross which then needs to cover mgmt fees and dead deal costs before it is in the carry.

For what it's worth, I also don't see a fund spending only $2M per year unless you are running really lean. I would assume two partners, a VP, an Associate, and a CFO/Admin would cost you ~$1.5M of base comp and you still need office space (in theory), travel, accounting, tax, legal, etc.

 

do you think those considerations equally bring in counting fees paid by portcos too e.g. some LP’s get a decent chunk of the portco ‘management fees’ but so do some of these costs are typically offset by.

you’re not wrong or anything obviously but maybe complicating it to where too many caveats/possible situations are considered?

 

The management fee point is a fair one, though I'd say the market has evolved over the past 5+ years such that LPs rarely allow a GP to keep portco mgmt fees and instead insist that they are passed through to LPs or offset LP fees.

Similarly, most companies in the middle market that are represented by reputable bankers (and lenders in the space) realize the fee is BS and they are typically negotiated away. If you are investing a $500M fund, you're probably looking at companies with max $10M of EBITDA, so you would probably be lucky to get away with a $500K annual mgmt fee.

To your direct question, yes, I could be over-complicating, but I did think it was important to point out that a $500M fund is very unlikely to result in $500M of gains because you can't call 100% of a fund, so I'd be a bit more conservative on the assumption since it drives so much of the value for the GP via the carry assumption.

 

SB'd all relevant points. Those are actually very important points that I missed - I have modified the calculation to reflect 2x return on 85% of the fund invested assuming 10% is taken out for management fees and the other 5% is either not invested at all or used to cover other misc expenses like fundraising costs, placement agent fees, etc... Adjusted firm posts to 80% instead of 50% for realistically assuming a growing team will have more mouths to feed and cover rent, traver, accounting, legal, admin and other expenses.. Let me know if there are other assumptions that need to be adjusted. This brings average tax rate closer to 21% and LTCG (carry/GP return) proportion of the income closer to 75% of the annual pretax income which slighly crosses $3.6MM.

 

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