Management fee discounts disappear from sight

The number of funds coming to market openly offering discounts for early bird commitments or big ticket sizes is dropping, according to research seen exclusively by Private Equity International.

The number of funds coming to market offering a discount on management fees is dwindling, according to new research seen exclusively by Private Equity International.

Just 12 percent of the funds included in MJ Hudson’s annual fund terms survey included the possibility of discounted fees in their LPAs. This represents a drop from the 2019 figure, which was 17 percent, and 2018 (24 percent).

The legal and fund services firm collated the fund term data from PE and venture capital funds seen by its LP and GP clients during 2019 and part of 2020. Of the funds, 41 percent were buyout, 32 percent growth capital and 21 percent VC funds. Other asset classes, such as infrastructure and private debt, were excluded from the study.

Discounts are frequently granted confidentially by a side letter, noted the report, so it is difficult to ascertain the extent of fee discounting in the market. However, discounts are often offered with transparency as incentives for LPs to either commit early to a fundraise or to write a larger cheque.

Headline fees and carried interest

While 2 percent is still the most commonly seen headline management fee rate – applying to 52 percent of recent fundraises by number – it only applies to a fifth of the total capital raised. The bulk of capital raised (44 percent) is subject to a headline management fee of 1.5 percent or less.

Most funds (91 percent) set carried interest at the conventional 20 percent rate, but nearly a quarter of funds (22.7 percent) offer a tiered or stepped carry arrangement, whereby the initial baseline carry share of 20 percent increases once a certain threshold is met.

“Our year-on-year research suggests this trend is growing, but we note that our sample this year also includes a slightly greater proportion of growth and turnaround funds, which may account for the change here,” the report noted.

The report continues: “Alternative carried interest models included within this year’s sample of funds included those where investors can opt for another class of fund interest bearing a higher carried interest rate and compensated by a lower management fee, or where investors are given the option to select different carried interest rates. This is usually linked to paying different management fee rates, with higher carried interest offset by a lower management fee.”

Other findings from the report:

  • This year a higher proportion of US managers are using European whole-fund distribution models.
  • There’s evidence the 8 percent hurdle rate is under challenge, with almost one-third of funds having no preferred return at all (a 6 percentage point increase on last year’s findings).
  • Almost all funds have GP clawback provisions (97 percent).

– This report was updated to change PPM to LPA in the second paragraph.