- Management Fee
- GP Commitment
- Carried Interest Overview
- Carried Interest – Preferred Return and GP Catchup
- GP Clawback
A private equity fund can generate fees in certain situations that are separate and distinct from management fees. These situations include:
- Break-Up (Termination) Fees. Break-up fees (also known as termination fees) are paid by a company to a private equity firm if the company terminates an agreement to be acquired by the private equity fund. This can occur, for example, if after entering into an agreement to be acquired by the fund, the company receives a competing bid and decides to break the agreement with the fund and take the competing offer. The idea behind break-up fees are to compensate the terminated buyer for the time and expense incurred with pursuing the broken transaction.
- Monitoring Fees. After the private equity firm acquires a company, it will provide ongoing management services to the company, for which the fund is paid an annual “monitoring” fee.
- Success Fees. When a private equity firm acquires a company, it may charge the company a fee in connection with the closing of the deal. These “transaction fees” or “deal fees” or “success fees”) are typically cash payments paid to the fund.
- Board of Directors Fees. After a private equity fund acquires a company, it is customary for principals of the private equity firm to become members of the board of directors of the company. The company will pay director fees to these individuals. Note that after acquisition, the portfolio company is typically now a privately-held company controlled by the private equity firm, and the individuals are members of a private company’s board of directors.
- Advisory Fees. Often, a private equity firm will advise its portfolio company on acquisitions of other companies, bank financings, sale of the company (or a division of the company), its initial public offering, and more. In these cases, the company pays the private equity firm with an advisory fee.
The total sum of all of these fees can be substantial. When these fees came into being, the private equity firms kept these fees, without providing any of the fees to the fund. This has changed dramatically, and now the custom is for these fees to offset the management fee by 100% of the fees or 80% of the fees. So, for example, if a private equity firm generated $1 million in fees from the portfolio companies from its Fund 1, then the management fee the firm receives from Fund 1 would be reduced by $1 million in the case of a 100% offset, or $800,000 in the case of an 80% offset.
Excluded Fees. Certain fees are excluded from the management fee offset. These can include fees paid to operating partners (individuals affiliated with the private equity firm, but who are not employees of the firm), or by fees paid to a consulting firm affiliated with the private equity firm, or director fees received from publicly-traded companies. (Many private equity firms have established consulting affiliates to work with portfolio companies and introduce the private equity firm’s “playbook” for operational improvements to the portfolio company.)