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Investors Push For Private Equity Fee Cuts

29 February, 2012

Investors are pushing for sweeping changes in the way private equity groups collect management fees in a trend that is set to bring down absolute fee levels.

At an industry conference in Berlin, several buy-out executives said they were being asked by investors to charge fees only on the money they have actually used for investments and not on overall capital committed to a fund.

James Coulter, founding partner at TPG Capital, said this would become a more common practice in the next few years particularly for larger private equity groups, which are already under pressure to lower management fees.

“Private equity firms no longer need fees just to switch their lights on,” the co-founder of one of the largest private equity groups in the world said at the Super Return conference.

“If a fund really needs the management fee to keep going you probably should not invest in them.”

Private equity groups have traditionally used a fee model in which they charge a 2 per cent management fee on the committed capital to pay for overhead costs.

A $10bn fund would charge a $200m fee from the first day of its existence.

But typically, a fund takes about five years to invest its capital and it only draws the money from its investors each time it acquires a company.

Since the financial crisis, investors have achieved considerable success in urging private equity groups to bring down fees as returns in the sector have fallen and as some large buy out groups have reaped big gains from the management fee alone, and not only from profit rewards.

A study by research group Preqin last year found management fees for new buy-out funds with more than $1bn had dropped to 1.7 per cent from the traditional 2 per cent.

“There are some disruptions in the industry,” said David Rubenstein, co-founder and managing director of Carlyle, the US private equity group that is about to go public.

“For the first time in many years … there is a desire to pay fees on invested and not committed capital and for the creation of special accounts.”

One senior private equity executive estimated that today, about five per cent of the money was invested in fund structures that charge fees on invested capital.

But he added that in the next 10 years, this could go up to 30 per cent of private equity capital.

Mr Coulter said fees would come down particularly as structures such as special accounts – funds that are tailor made for one investor – would become more common.

“We will see funds with quite substantial fee breaks for investors,” he said.

Mario Gianinni, chief executive at Hamilton Lane, one of the largest investors into private equity funds in the world, said: “You will see a lot of investors using predominantly special accounts.”

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Investors Push For Private Equity Fee Cuts

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