What makes the fees and terms of one private equity deal better than another?
A new study by Callan examined 90 private equity partnerships to compare their fees and terms structures with the aim of helping institutional investors better evaluate these funds. Notably, the funds studied tilted toward the buyout variety (76 per cent) and to North America (80 per cent).
“We found a relatively high level of uniformity for fees and terms among the partnerships in our study, indicating that [limited partners] faced constraints on their bargaining power with [general partners],” said the study. “At this point in the cycle, GPs are in the driver’s seat, which in our view makes careful manager selection even more critical. Of course, that may change as the impact of the COVID-19 pandemic resets the dynamics of the private equity market.”
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The study found a $10-million minimum LP commitment is quite common among the industry, appearing in just under half (46 per cent) of partnerships. About a quarter placed higher minimums for LPs, usually with an eye toward constraining the LP base to larger investors.
As for GPs, the data showed three per cent is standard for their commitments, with lower commitments potentially indicating a lack of alignment between GPs and LPs. “Commitments on the higher end typically involve balance sheet capital from the GP.”
As for management fees, the study looked at fees paid during the investment period — usually the first five or six years of the fund’s existence — as well as after. The median management fee during the investment period was 1.75 per cent and was usually paid on committed capital. The median fee dropped to 1.5 per cent after the investment period and was almost always paid on invested capital. A few (17 per cent) of the funds studied didn’t have this step-down quality, with management fees staying paid on the same capital base over the fund’s whole life.
“Management fees higher or lower than our findings can signal to investors whether they are overpaying a general partner or benefiting from fee savings,” noted the study.