Management Fee in Private Equity
The management fee is the annual amount a private fund pays its general partner to cover the cost of running the partnership, usually calculated as a percentage of committed or invested capital.
Reviewed by José Vasquéz, Managing Partner · Last reviewed
Structure
The fee has three moving parts: a rate, a basis and a clock. The ILPA Model LPA Term Sheet sets out the pattern ILPA recommends.
- Investment period: the fee is a stated percentage per year of each limited partner's commitment, payable quarterly in advance.
- After the investment period: the basis shifts to capital contributed to acquire investments, less the cost of investments realized, written off or permanently written down.
- Offset: each quarterly installment is reduced by the limited partner's share of fee income that the general partner or its affiliates collect, such as transaction fees, and any unused excess rolls forward.
The formula for any year is rate multiplied by basis. The ILPA Principles 3.0 (page 12) add that the fee should step down at the end of the investment period to a percentage of unrealized cost, and that a manager with a predecessor fund should consider basing the first fees of a follow-on fund on invested rather than committed capital.
Worked Example
Take a hypothetical $100,000,000 partnership with a five-year investment period and an annual rate of 2.0 percent throughout. Net invested cost is assumed to fall from $80,000,000 in year 6 to $10,000,000 in year 10 as investments are sold.
| Years | Basis | Annual fee |
|---|---|---|
| 1 to 5 | $100,000,000 committed | $2,000,000 each year, $10,000,000 in all |
| 6 | $80,000,000 net invested | $1,600,000 |
| 7 | $65,000,000 | $1,300,000 |
| 8 | $45,000,000 | $900,000 |
| 9 | $25,000,000 | $500,000 |
| 10 | $10,000,000 | $200,000 |
Fees total $14,500,000 over ten years, or 14.5 percent of commitments. If limited partners pay in the full $100,000,000 and nothing else is charged, $85,500,000 reaches investments. A gross multiple of 2.0x on that amount returns $171,000,000, which is 1.71x of paid-in capital before carried interest. Fees alone cost 0.29x of paid-in capital, or 14.5 percent of the gross proceeds.
Offsets work against the same schedule. A $600,000 transaction fee paid by a portfolio company is applied against the next quarterly installment of $500,000 (2.0 percent of $100,000,000, divided by four), which falls to zero, and the remaining $100,000 rolls into the following quarter.
How the Private Equity Management Fee Is Negotiated
Rates cluster in a narrow band while the basis, the step-down and the offset do most of the work. The ILPA 2021 market-terms report described management fee rates as stable at 1.5 to 2.0 percent and found that investors in funds above $1.5 billion reported rates below 2.0 percent a majority of the time. It also found that 25 percent of responding limited partners saw administrative expenses, such as in-house legal and accounting, shifted outside the fee.
What It Means for a Limited Partner
The fee is paid whether or not investments perform, which makes it the first test of alignment. A limited partner should ask what the fee is meant to cover and compare it with the manager's budget; ILPA Principles 3.0 ask a first-time manager, or one proposing a higher fee, to supply that budget. Next, confirm the step-down, because a fee that keeps running on commitments after the investment period is paid on capital that is no longer deployed. Then test the offset: ILPA states that portfolio company fees should be 100 percent offset against the management fee, and the 2021 report notes that the offset has been eroded by exclusions for fees paid to operating partners and other related parties. Finally, request fee reporting on the ILPA Fee Template, which the 2021 report calls the most common reporting tool.
In Life Sciences and Healthcare
A biopharma portfolio can sit in a fund for a decade or more. The BIO, Informa and QLS Advisors study of 2011 to 2020 programs measured 10.5 years on average from Phase I to approval, so the post-investment-period fee on net invested capital can run for many years on assets still in the clinic. ILPA Principles 3.0 limit fund term extensions to one-year increments, at most two, and say no fee should be charged after the original term unless limited partners amend the agreement to allow it. A specialist team that uses scientific advisers should also confirm whether their cost sits inside the fee or is charged to the partnership.
Frequently Asked Questions
How is a private equity management fee calculated?
A private equity management fee equals an annual rate multiplied by a basis. During the investment period the basis is usually each limited partner's commitment. Afterward it is typically invested capital net of realized and written-off cost. On $100,000,000 at 2.0 percent, the first year costs $2,000,000, paid in quarterly installments of $500,000.
What is a fee offset?
A fee offset reduces the management fee by fee income that the general partner or its affiliates collect from portfolio companies, such as transaction or monitoring fees. ILPA Principles 3.0 say portfolio company fees should be 100 percent offset. In the ILPA model term sheet, an offset cannot reduce an installment below zero, and the excess rolls forward.
What management fee is standard?
The ILPA 2021 market-terms report put rates at 1.5 to 2.0 percent, with funds above $1.5 billion reporting below 2.0 percent most of the time. Rate matters less than basis, step-down and offsets, which determine the total in dollars. The J-curve and commitment-pacing model shows how fees weigh on early-year net asset value.
Related Reference
Fee terms are part of the structure discussed in growth equity. Related entries: Hurdle Rate (Preferred Return), Carried Interest and GP Commitment.