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Mark Spinner, partner, Eversheds

Fund investors look for revolution in fee structure

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Prominent investors are using the recent market turmoil as an opportunity to pressure private equity firms into changing the way they organise their fee structures. Sovereign wealth funds have been particularly vociferous about changing the traditional model of management fees of up to two percent. Mark Spinner (pictured), partner at international law firm Eversheds, comments…

The thorny issue of ‘excessive management fees’ has been around for a little while now and with some of the mega leveraged buy-out funds it is not hard to see why. A 2% annual management fee on a Fund of EUR6 billion amounts to a very significant annual sum of EUR120,000,000 which, regardless of the size of the investment team, is likely to leave the General Partner (GP) with significant surplus funds even after all of the overheads have been paid. If you reckon on each GP having a minimum of two Funds under management at the same time then the issue of surplus management fees is simply compounded.

Add to this the retention of some, or all, of the deal related transaction fees, which are ordinarily calculated as a percentage of capital deployed into the particular transaction, and this all adds up to a very significant annual income.

Traditionally the 2% management fee was intended to fund the operating costs of the GP whilst investments were made, matured and exited. The real carrot was always the prospect of sharing 20% of the capital gain, subject to a ‘hurdle’ that is ordinarily around 8%, by way of carried interest. However as fund sizes have grown, the percentage management fee payable has remained remarkably constant, meaning significant sums are now payable by way of management fee which are not necessarily linked to the overhead structure which they were designed to support.

Whilst some investors are likely to find a 2% management fee slightly rich, many will see it as a price worth paying to get access to the top quartile GP’s whose superior returns outweigh the fees and carried interest payable. On balance I would expect the question of management fees to continue to be debated and for some funds, particularly those raising significant follow on funds, to come under pressure. For the most part, however, I suspect that the 2/20 remuneration model (2% management fee and 20% carried interest), which has been pretty much market standard now for a number of years, to continue.

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