PE fees waning after the SEC’s warning

The percentage of private equity deals featuring transaction fees and/or monitoring fees has been on the decline since the Securities and Exchange Commission’s (SEC) top inspector, Andrew Bowden, delivered his “Spreading Sunshine in Private Equity” speech back in May, a study from private equity research firm Pitchbook found.

According to the study the percentage of transactions in Q2 charging transaction fees in the US is now 32 percent, down from nearly 70 percent in Q1, and monitoring fees at 29 percent, down from just over 50 percent.

For the minority of GPs that still do charge fees, they seem to be increasing their monitoring fees (up from 4.2 percent to 4.5 percent as a percentage of EBITDA) while transaction fees have kept fairly steady.

Bowden’s speech at the 2014 PEI Private Fund Compliance Forum put LPs on alert and many have been asking GPs to explain the precise nature and quantum of their fees and expenses, with reference to the LP agreement signed at the outset of the fund. They have also demanded to know whether the SEC has examined the manager in question, and if so, what the regulator concluded about the policies in place.

The SEC takes particular exception to accelerated monitoring fees, where GPs have portfolio companies sign agreements obligating them to pay monitoring fees for ten years (or longer) – even if they end the relationship with the company via an exit much sooner.

Bowden said: “Some of these agreements run way past the term of the fund; some self-renew annually; and some have an indefinite term. We see mergers, acquisitions, and IPOs triggering these agreements. At that point, the adviser collects a fee to terminate the monitoring agreement, which the adviser caused the portfolio company to sign in the first place. The termination usually takes the form of the acceleration of all the monitoring fees due for the duration of the contract, discounted at the risk-free rate. As you can imagine, this sort of arrangement has the potential to generate eight-figure, or in rare cases, even higher fees.”

He added that there was usually no disclosure of the practice at the point when the agreement was signed.