In pursuit of fees

Today’s Wall Street Journal asks, why are private-equity firms raising mega-buy-out funds?

Consider the compensation structure of a $19 billion fund, which is the size Goldman Sachs is targeting for its latest fund. Typically it will take about 10 years for that money to be deployed and then returned to investors. The fund manager typically takes a fifth of those profits each year for the last five years of the funds, after clearing certain minimum-return hurdles.

But there’s more. Private-equity funds also charge an annual management fee of up to 1.5% on the money they put to work. For a $19 billion fund, that could be as much as $235 million in a year. In addition, most private-equity firms charge transaction fees, a bit like investment bankers do, for putting together their deals. Blackstone is charging its investors some $200 million for completing the $39 million takeover Equity Office Properties.

Using a model developed by Private Equity Manager, a trade publication, it is possible to project how these fees on investors’ money add up. Over 10 years, a fund like the one Goldman is aiming for could throw off $7.8 billion to its managers. That’s equal to about 40% of the assets committed to the fund.

To be fair, the pension funds and institutions that commit their money to big buyout funds are happy to pay fees like these if they can double their money – as has been the case historically. But with so much money chasing outsized returns, it’s not clear that will be the case in the future.

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