As a new resource to this blog, I will be answering the frequently asked questions that I receive by e-mail each week. Continuing with yesterday’s answer on private equity management fees, I thought we’d take a look at private equity performance fees. (There are more detailed videos available through the Private Equity Training program we offer).
What is the private equity performance fee? A private equity performance fee is the fee charged on the profits made by the fund. So a general partner will take usually a 20% cut of the fund’s return. A private equity performance fee is commonly referred to as the carried interest or simply the carry.
The carried interest compensation typically ranges from 20-30% of profits which is a substantial amount of money for the fund’s investors. This may vary by the performance, experience and investor enthusiasm of a fund. If a fund is ran by a highly-reputable management team, has a great track record and investors are lining up to get in the fund, then they may charge a higher than 20%-average carry; conversely, a new fund or one that expects trouble in attracting investors may lower its fees and take a smaller percentage of the profits.
A private equity fund is a partnership created to obtain a significant (often majority) stake in an expanding or underperforming company. Outside investors, the limited partners, provide most of the funding capital typically 90-97%. The remaining funding of 3-10% is provided by the general partners of the fund who in turn receive management fees. The typical compensation set up for private equity fund managers is 1-2% of the total fund assets and the carried interest. This arrangement is often very beneficial for the manager and serves as a method for investors to motivate and reward good performance by the general partners.
In a private equity fund, the fees are taken exiting the investments and distributing capital to the investors, then the GP takes the carry and distributes that to the management team and a smaller cut to mid-level employees depending on their compensation structure. For many private equity professionals, the carry represents a substantial incentive and often a substantial bonus on their base pay.
I hope this explanation of the private equity performance fee has helped you better understand this important term. If you have further questions you’d like answered, check out our frequently asked questions page here.
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