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.
Thanks m8, to respond to (b). I have two reasons for this
(1) Their returns are decent and after crunching the numbers the returns to me certainly wouldn't be mind blowing. Given the large amounts of dry powder entering the industry it would be even tougher to achieve good returns. Just feel that there are better opportunities elsewhere (eg. crypto once the bloodbath is over).
(2) I am not sure how long I would be at this place and I believe that carry would vest over the term of the fund. So if I leave after two years, would that be like paying the full LP commitment but only being entitled to two years worth of carry. Doesn't sound worth it to me if this is the case. I have not dared ask too many questions if not it might appear that I seem uncommitted to stay.
Btw, would you have insights into the carry % at analyst and associate level? If you prefer, could I PM you?
Thank you
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%.
It's extremely common/standard for one to have to "pay" for their carry.
Think about it - you're investing in the fund, not just being given a profit share with no skin in the game.
Thanks Fugue. appreciate the insights.
Most people consider it a benefit btw. If the fund you're at produces solid returns then why not?
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.
Could you explain why you say "the cash might not always come out of your pocket"? Who pays it then?
Doubt it is possible for a secondary fund to hit 2x net. When I look through our previous investment memos, none of them target anywhere near that. More like 1.4x to 1.5x net.
The fund was raised early 2016. As for distributions, wouldn't this depend on the underlying managers? Doubt we can do anything about it.
Appreciate the insights and thank you.
If a GP owns 1% of the fund, and charges a 2% management fee annually, there would be greater revenue than commitment. And depending on overheads and timing, maybe more profit than commitment.
If you owned 0.5% of the GP, you would have rights to 0.5% of all profits and 0.5% of the commitment for a cash call. So if there is cash at the GP, it makes mores sense to pay for your commitment rather than distributing the profits via dividends which you would be taxed on and then you get cash called later..
Maybe a silly question, but 1.4-1.5x over how many years?
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.
I had the same thinking as well so I'm pretty confused / surprised with the answers above.
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.
so if it was just co-invest, you would just get the first part (250k x 2), but from also having carry you're getting the co-invest part plus carry from the fund's total profit.
Exactly. Its 2 different streams of distributions, 1 you pay for (LP commitment), the other you don't (carry).
Exactly - again, on the real estate side I've seen both pretty common, but unless you are at a very high/senior level, the LP commitment usually yields better net dollars to you than the straight carry since you actually put skin in the game/money where your mouth is. The only time I've seen this flipped is when a senior partner/key guy is around to see an entire fund liquidated on the back end.
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.
Are you basically calling the GP's promote a carry instead. If so then I have seen that on a GP side where you buy in with LP and then the extra promote or Carry you get is especially free equity in the project on sale.
I am getting confused by all this, because Carry is free. Most people who are attached to a Carry in their compensation do have more interest in the project company or deal.
this excludes the fact that theres a high water mark on the fund. the fund wouldn't pay 20% on the full 1.0x of value created.
Where do your friends work? Have some dry powder on hand trying to invest. I (family money) invest through our FA and there is crazy placement and management fees. My employer only offers co-invest for VP above level.
I'm in CRE/REPE so it's not exactly apples to apples, but this situation sounds strange to me. I think you'd be crazy not to put some skin in the game, this is literally one of the main reasons that people get into this side of the business because the upside/returns can be so good as petergibbons mentions above.
I agree with this. You'd be hard pressed to find a better place to put your money than a quality secondary fund that has consistently generated 1.4-1.5x / 15% returns.
Hey m8 , is 1.4x-1.5x considered good? I don't have access to preqin so can't see how such performance stacks up against other funds. Thank you very much for your insights.
Following up on Fugue's point, it sounds like me, youngblood12, and Sham Wow had it right? There is "co-invest" on which you invest in a deal (at mine, it's unlimited - at others, it may be capped at a certain amount) and get gross returns.
Then, separately and unrelated, and typically to more senior employees (though I think it's now market to pay it to anyone joining post-MBA as a VP, and I've even seen some senior associates get it), there is "carry" which is free and obviously comes out of the 20% fund carried interest... which hopefully everyone working in PE knows.\
The example from petergibbons confuses me because it co-mingles the 0.1% example numbers by tying them together - in reality, the "paid for" co-invest and the "free" carry may be entirely different amounts - right?
Am I summarizing this right? Thanks.
EDIT: I also strongly agree with everyone -- not co-investing in your fund would be an extremely bad look.
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