When should fees fall?

Private equity firms large and small are having trouble getting any deals closed in the current economic environment. It is therefore likely that more and more limited partners will begin questioning why they are paying so much in fees when so little work is getting done.

“A sponsor that was able to have a first closing in the last six months and started charging a management fee may not be pursuing transactions in this environment,” says Roger Singer, a partner in the New York fund formation practice of Clifford Chance. “LPs may support that decision but may ask why they are paying the sponsor a management fee not to actively pursue transactions. It is causing a re-examination of the management fee and whether the amounts are appropriate.”

Already San Francisco-based TPG has cut its initial $6 billion Financial Partners Fund by 25 percent and cut management fees across the board, while London’s HG Capital cut the management fees for its latest fund, capping them at 1.75 percent. Meanwhile, in December London-based Permira allowed investors to cap at 60 percent their original commitment to the firm’s fourth buyout fund, while giving LPs who increased their commitments the incentive of paying no management fees on any new commitments to the fund.

But while at least two additional private equity executives told PEI Manager that they have heard from LPs wanting to discuss management fee relief on current funds, it is not likely to be an issue many GPs will have to worry about with existing funds, at least for now.

“I think LPs understand that there is not anything that they can do on their current commitments because it’s a legal binding agreement that they signed, and most of these funds can’t give fee relief to one without giving fee relief to everybody,” said Mark Maruszewski, partner at New York-based Pomona Capital. “Most LPs realize that and I haven’t heard a lot of chatter about them wanting fee relief.”

“LPs may ask why they are paying the sponsor a management fee not to actively pursue transactions. It is causing a re-examination of the management fee and whether the amounts are appropriate”

While experienced LPs are unlikely to attempt to renegotiate fees on existing funds, many expect that new fundraisings may give rise to pressure on the management fee. LPs who are struggling to fund commitments, and who may feel that GPs are not dealing with similar pain or worried enough about fund performance due to management fee income, could begin demanding to know why a GP needs, for instance, a point and a half on a $5 billion fund.

Singer says that in order to ensure that LPs feel like they are being treated fairly, a GP managing, for example, a $500 million fund may want to renegotiate fees based on whatever amount hasn’t been invested by a certain period. If it looks like $200 million will not be spent, they may waive the fee with a provision to charge it retroactively if that amount does get put to work.

Whether a manager is planning such a change or not, Singer says they should not wait to make the case to LPs, as the alternative is working off a less-desirable proposal. “A lot of times we tell sponsors that if they shape the debate, it is going to be much better than if they don’t say anything and let people come up with their own ideas. Controlling the conversation is a valuable thing.”