Private Equity 20 Lectures (5) How are management fees charged for private equity funds?
After the money is invested in the fund, how does the money go within the fund, and how are the GPs and LPs split? How do management fees and performance fees work? Here we will explain the management fee and performance fee of the fund in two separate issues.
I. The difference between management fee (management fee) and performance fee (performance fee):
GP can get two money: one is the management fee (management fee), the other is the performance fee (performance fee), we can understand the difference between these two concepts from several angles: 1:
1. proportion: management fee and performance fee of these two parts of an industry term called "Two and Twenty (2% &20%) two and twenty principles", this rule applies to all private equity funds, including venture capital funds and hedge funds. Of course, not all funds will strictly adhere to this, usually many funds will try to attract investors will also try to lower the two figures, so you will see that sometimes the management fee is only a few percent, performance fee is only a few percent. This issue we will mainly talk about the management fee (management fee) part, which is the front of this 2%, and the next issue will mainly talk about the performance fee (performance fee), which is the back of this 20%. 2.
2. analogy: we can say that the management fee (management fee) and performance fee (performance fee) are base salary and commission. The management fee is equivalent to the GP's base salary. No matter how well the fund manager manages the fund, whether the fund is losing or gaining, the LP's money inside will be taken away by the GP 2% management fee.
3. base: this 2% is calculated based on the total amount of funds (jargon called "asset under management", AUM, asset under management) as the base.
4. frequency: In addition, this 2% management fee is annually charged every year, and so the calculation is actually quite a large amount of money.
From these four perspectives you will understand why in real life you will see that most GPs are not actually looking at the project, but pulling investment, because this 2% management fee is the hardcore crop of the drought and flood. Just like when we look for a job, although the commission is also very important, but first of all, we must also look at how the base salary, after all, the commission is not always available.
The factors that determine the management fee (management fee)
1. the size of the fund. Generally speaking, the larger the fund size, the lower the management fee, the smaller the fund size, the higher the management fee. Because after all, the management fee is based on the total amount of funds under management (AUM, asset under management) to calculate, and the total amount of funds under management increased by 10 times, the management workload is not directly increased by 10 times, so the larger the fund can be more diluted management fee.
2. the development stage of the fund: usually in the first 3-7 years of the fund's active investment period, the fund's management fee is relatively high is usually the standard 2%, and to the additional period, the exit period, the GP to do things are relatively simple, this time the management fee will be reduced to 1.5% or 1%.
Third, the management fee collection channels
Another is the channel through which the fund company's management fee is collected. Smaller funds usually do not set up a fund management company, and use GP LLC to collect management fees directly.
Large funds, especially those with multiple sub-funds, often set up a management company, which we call Management Company LLC, to collect management fees through the name of this company.
So some people will ask, what is the relationship between this GP and Management Company LLC? From the following example, we can see that both GP and Management Company LLC are behind the same group of people, that is, GP and their fund managers, but their roles are different, GP is in charge of investment, Management Company is in charge of things not related to investment. Some people may ask, "Is there anything else in this fund that is not related to investment? Yes, there are many. In the fund, investment itself is a very specialized job, which is to look at the project and decide how much money to invest in which project. However, there are a lot of administrative and auxiliary day-to-day work that needs to be done, such as fund set-up, contact with lawyers and accounting firms that provide services, all these things also need to be done, then these trivial things are the responsibility of the management company.
That said, careful friends should also find out, yes, the fund-related legal and financial work has to be done by additional people, so how to calculate this part of the cost? I can first tell you a short answer, these additional third-party fees collectively known as Fund Expense, is required to be calculated separately, not included in the management fee we introduced above, and the wool is on the sheep's back, these costs will eventually be passed on to the LP head. So it sounds like LPs are going to be skinned! We won't go over these in the video, so if you are interested, get your LPA and contact me separately.
