Fee offsets are one of those sneaky terms that look harmless but can actually be somewhat insidious. Fees can generally only be offset to the extent that management fees are being generated (and offsets can be carried forward). However, near the end of a fund's life (>Year 10), when management fees are no longer being generated, all those fees just go straight to the GPs bottom line because there is nothing to 'offset' them against.
Don't the GP also get some kind of incentive based compensation fee in addition to their standard management fee? I think the incentive based compensation is usually a percentage of both the realized and unrealized gains the fund earns on an annual basis. Or am I thinking about something else?
Thanks for your comment Faheem. Yes that's correct, so that incentive compensation typically comes in the form of a carried interest. But that depends on the performance of the fund. Important to also bare in mind that fees received by the investment manager are taxed at ordinary income rates and carried interest - when structured properly - is taxed at the capital gains rate, which is lower.
What sort of “hurdle rates” are you currently seeing in LPAs and how many funds currently have these? Assume they would be more prevalent in more cash-generative businesses (e.g. real estate, old world companies) and leas so in tech world?
Thanks for your comment John. Depends on the asset class. Re: tech I'd say that's true insofar as venture capital funds typically do not have a hurdle rate. However PE strategies that focus on more established tech companies are different. Current market hurdles generally are ~7-10%.
I’ve been following with interest the writings of Ludowic Philippou on funds and how the advertise returns. I wonder how long it is until we start seeing smaller funds advertise for capital on the basis of more creative income sharing models (a little bit like how lawyers are endlessly under pressure to come up with fee structures that aren’t just the billable hour).
Thanks for your thoughts Jamie - yes, there is always innovation around fees, and the debate around fees has been much more storied in the world of regulated funds (such as mutual funds), especially the so-called 12b-1 fees, charged to existing mutual fund investors for purposes of marketing the fund to newer investors and other such fees. As for lawyers, there is some momentum for flat billing - to be seen!
Fee offsets are one of those sneaky terms that look harmless but can actually be somewhat insidious. Fees can generally only be offset to the extent that management fees are being generated (and offsets can be carried forward). However, near the end of a fund's life (>Year 10), when management fees are no longer being generated, all those fees just go straight to the GPs bottom line because there is nothing to 'offset' them against.
Thanks for the helpful clarification Chris, appreciate you taking the time to read and offer your thoughts.
Don't the GP also get some kind of incentive based compensation fee in addition to their standard management fee? I think the incentive based compensation is usually a percentage of both the realized and unrealized gains the fund earns on an annual basis. Or am I thinking about something else?
Thanks for your comment Faheem. Yes that's correct, so that incentive compensation typically comes in the form of a carried interest. But that depends on the performance of the fund. Important to also bare in mind that fees received by the investment manager are taxed at ordinary income rates and carried interest - when structured properly - is taxed at the capital gains rate, which is lower.
Got it. And the LP agreement is where one would structure that incentive fee in the form of a carried interest, right?
Yes!
What sort of “hurdle rates” are you currently seeing in LPAs and how many funds currently have these? Assume they would be more prevalent in more cash-generative businesses (e.g. real estate, old world companies) and leas so in tech world?
Thanks for your comment John. Depends on the asset class. Re: tech I'd say that's true insofar as venture capital funds typically do not have a hurdle rate. However PE strategies that focus on more established tech companies are different. Current market hurdles generally are ~7-10%.
I’ve been following with interest the writings of Ludowic Philippou on funds and how the advertise returns. I wonder how long it is until we start seeing smaller funds advertise for capital on the basis of more creative income sharing models (a little bit like how lawyers are endlessly under pressure to come up with fee structures that aren’t just the billable hour).
Thanks for your thoughts Jamie - yes, there is always innovation around fees, and the debate around fees has been much more storied in the world of regulated funds (such as mutual funds), especially the so-called 12b-1 fees, charged to existing mutual fund investors for purposes of marketing the fund to newer investors and other such fees. As for lawyers, there is some momentum for flat billing - to be seen!