Hello World!
Compensation in the PE world can be a bit of a black box. I sometimes get approached by folks who are perplexed by their compensation packages at a middle market PE fund. There is little consistency even across funds of the same size. On the surface, this doesn't exactly make a whole lot of sense. After all, it is easy to calculate a PE firm's revenue: simply take the fund size, multiple by 2%, and there you have a pretty good estimate. Right? Wrong! Here are a couple of the dynamics at play "under the hood" that can have a profound impact on the PE firm's revenue and therefore compensation:
1. Anchor Investors & Side Letters
Economics are not the same for every Limited Partner. Many funds have "Anchor Investors." Anchor Investors earn that status a few ways. Often times the Anchor Investors are the largest Limited Partners by a meaningful scale, accounting for 10% or more of the committed capital. They usually commit capital at the beginning of the fund raise (during the first close) and help build momentum for the fundraising. In return for this risk, Anchor Investors often negotiate a Side Letter. The Side Letter stipulates special conditions or exceptions for that particular LP. While many things can be included in Side Letters, better economics can certainly be one of them. So while 2 and 20 may apply to the majority of the LPs, a couple Anchor Investors may actually be at 1.5% and 15% or lower!
2. Portfolio Company Fee Sharing
It is no secret that PE firms charge a few different fees to their portfolio companies. The usual suspects are a closing fee (initial acquisition), monitoring fees (during ownership), and exit fee (liquidity). These fees are customarily distributed to LPs in one form or fashion. The percentage distributed to the LPs is set at the beginning of the funds life (during fundraising). If a fund has a 100% fee offset, ALL of the fees are distributed to LPs (or used to offset capital calls). An 80/20 construct, which is not uncommon, would permit the private equity firm to retain 20%. This is absolutely massive in terms of a PE firm's revenue and is a large factor in determining how much money is available for compensation, particularly if a great deal of compensation is an annual bonus.
There are a number of other factors at play, such as active legacy funds and their corresponding fee arrangements. However, next time you are negotiating compensation with a PE firm for a senior position, try to get an appreciation for these two dynamics. Ask for a copy of the fund's Private Placement Memorandum, which typically outlines the fee sharing arrangement and the general fund pricing structure. It isn't foolproof, but this could very well explain why your buddy at a similar size fund is getting paid twice as much!
Mod Note (Andy): Best of 2016, this post ranks #36 for the past year
welcome back CB! how's life treating you now
@the_ferry - Sorry, I can't speak to Fund of Funds compensation structure.
Mentioned it in the other thread, it's great to see you back. I hope things have been well. It's fantastic to see some of the OG guys back on the forums.
thanks for the post CB!
Thanks, great point on Anchor investors...and I didn't even know that about the fees. It would be interesting to know what % remit 100% of the fees and what % of MM funds remit closer to 80%.
Hope all is well and great to see you in the forums again :-)
Great post. +1
We need more informative posts from members like these and less "what bschool can I get into" and "breaking into banking" nonsense. Kudos.
Not to mention the overused "What color tie should I wear to work?" and "Which company's accessories are appropriate for my SA stint?"
Lmao I wonder how disappointed you are with the content now.
Great points! Thanks for sharing!
thanks for doing this. Any insights to provide about compensation at PE fund of funds?
This is really interesting. I knew comp at PE funds of similar sizes could vary but didn't understand the magnitude.
Great post. Thanks!
For some stats on this, look at the spread between "low" and "high" compensation in this report: http://www.heidrick.com/~/media/Publications%20and%20Reports/2015-North…
Very good points - I think very very few if any funds really get 2/20. Another point to add and something I've never seen mentioned on this site in regards to fund fees is Placement Agents.
Funds hire placement agents all the time. I was dumbfounded at the amount of money a placement agent can take for getting a fund raised. Placement agents can charge 2% or more of the total fund size - this reduces the management fee, spread out over time. For Hedge Funds I've seen placement agent fees that are as high as 40% of the 2/20.
Also - some GPs sell a portion of the GP to an anchor LP - this anchor not only gets a lower fee structure but gets a piece of the total GPs revenue.
Based on admittedly only a few data points this is very true - generally carry holds up ok but the 2% gets significantly squeezed. I've also seen multiple LP classes (e.g. you can have a lower fee for first close, lower fee but higher carry, etc)
This seems to be pretty similar to VC fee structures. Made me think of these two great posts that break it down in detail: Larger VC firm: http://avc.com/2014/05/vc-fund-economics/ Small VC firm: http://www.thisisgoingtobebig.com/blog/2014/5/12/the-economics-of-a-sma…
carry is almost always 20%, the very largest LPs (SWFs, Canadians etc) might be able to get a small break, but nowadays they mainly negotiate for first look at co-invests rather than fee discounts.
Large funds usually go for anywhere between 1.5% - 1.9%, sub $1bn funds are still largely 2/20%. Again the largest LPs will get a little below this, but will generally try to reduce their fee burden through co-investments, which obviously have no fees.
Vast majority of funds offset 100% - first time funds and some $500m funds will try and take 20-50% of transaction fees but it is very unpopular with LPs.
Above poster is correct, first closers will generally get a 10-15bps fee discount / holiday.
I recently read a prospectus for a MF that everyone here would know, and they had a ton of fee categories. If you were an investor in a prior fund, and committed big dollars (9 figures or more), you could be charged as little as 1 & 10. Also is it universal that co-invest has no fees? I thought funds could grab 10-20 bps for that occasionally.
I've heard of one mega fund charging the full 2/20 on a specific co-invest. But that was truly a once in a lifetime investment opportunity that everyone wanted a piece of.
Posts like this are great. Thanks CB, have a SB.
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