Читать книгу Mastering Private Equity - Prahl Michael - Страница 12

OR WHO EARNS WHAT?

The typical fee structure of a PE fund is designed to align the economic interest of the PE firm and its fund investors. The fee structure in PE is commonly referred to as “2 and 20” and defines how a fund’s investment manager and GP – and in turn its PE professionals – are compensated: the “2 %” refers to the management fee paid by the LPs per annum to a fund’s investment manager while the “20” represents the percentage of net fund profits – referred to as carried interest or “carry” – paid to its GP. The clear majority of profits, 80 %, generated by a fund is distributed pro rata to a fund’s LPs. As long as carried interest remains the main economic incentive for PE professionals, their focus will continue to be on maximizing returns, which in turn benefits the LPs. Exhibit 1.7 visualizes the flow of fees and share of net profits to the entities involved in a PE fund.

Exhibit 1.7 PE Fees and Carried Interest

Returns in PE are typically measured in both internal rate of return and multiples of money invested.20 Given a fund’s cost structure, its net return – that is, the return on capital generated by the fund net of management fees and carried interest – is the relevant metric for its investors and LPs will ultimately define success on that basis at the end of the fund’s life.

We take a detailed look at fees and carried interest below.

MANAGEMENT FEES: A PE fund’s investment manager charges the fund – and ultimately its LPs – an annual management fee to cover all day-to-day expenses of the fund, including salaries, office rent and costs related to deal sourcing and monitoring portfolio investments. In the early days of PE, the management fee charged was an almost consistent 2 % per annum, yet currently it ranges from 1.3 to 2.5 % depending on the size and strategy of a fund and the bargaining power of the PE firm during fundraising. For example, it is accepted that smaller, first-time funds will charge higher fees to cover their fixed costs, while large funds and mezzanine funds often charge lower fees. Since the global financial crisis of 2008 management fees have come under pressure, sometimes in an indirect way, through a sizable increase in free or discounted co-investment opportunities for LPs.21

Management fees accrue from a fund’s first closing onwards and are usually paid either quarterly or semi-annually in advance. Management fees are charged on committed capital during the investment period, and on net invested capital after the investment period; the rate charged on invested capital may step down from the initial percentage.22 This fee structure causes fee revenue to drop over the lifetime of a PE fund as capital is deployed and exits occur. Early in a fund’s life, management fees are typically drawn directly from investors’ committed capital, while proceeds from profitable exits may be used to offset management fees later in a fund’s life.

OTHER FEES: An investment manager may charge additional fees to the fund, particularly in the context of a control buyout. The main fee categories are transaction fees linked to a fund’s investment in and exit from a portfolio company and monitoring fees for advisory and consulting services provided to portfolio companies during the holding period. Other fees also include but are not limited to broken deal fees, directors’ fees, and other fees for services rendered at the fund or portfolio company level. Over the last decade, management fee offsets have increasingly been included in LPAs; when these offsets are in place, management fees charged to the LPs are reduced by a percentage of “other” fees collected by the fund – historically between 50 and 100 %, now trending towards 100 %. These offsets reduce the fee burden for LPs and shift a portion of the fee-based compensation from the GP to the limited partnership as a whole.

CARRIED INTEREST: Proceeds from successful exits are distributed to a fund’s LPs and its GP in line with a distribution “waterfall” set out in a fund’s LPA.23 Carried interest is the share of a fund’s net profits paid to its GP – typically 20 % – and serves as the main incentive for a PE firm’s principals. In a typical distribution waterfall, PE funds will return all invested capital and provide a minimum return to investors – a fund’s hurdle rate24 or preferred return – before any carried interest is paid out to the GP. After the hurdle rate has been reached, PE funds will typically include a “catch-up” mechanism that provides distributions to the GP until it has received 20 % of all net profits paid out up to this point. Thereafter, all remaining profits are split at the agreed-upon carried interest percentage (80−20). Should a GP for any reason receive more than its fair share of profits, a clawback provision included in a fund’s LPA requires GPs to return excess distributions to the fund’s LPs. Exhibit 1.8 shows the basic steps common to all distribution waterfalls.

Exhibit 1.8 PE Fund Distribution Waterfall

The industry uses two standard models to calculate distributions to LPs:

● All capital first: Also known as a European-style waterfall, this structure entitles a GP to carried interest only after all capital contributed by investors over a fund’s life has been returned and any capital required to satisfy a hurdle rate or preferred return has been distributed.

● Deal-by-deal carry (with loss carry-forward): Also known as an American-style waterfall, this structure entitles a GP to carried interest after each profitable exit from a portfolio investment during the fund’s life, but only after investors have received their invested capital from the deal in question, a preferred return and a “make whole” payment for any losses incurred on prior deals.

A detailed description of distribution waterfalls together with examples of carried interest calculations can be found in Chapter 16. Fund Formation.

A Look Back at the Last 45 Years

By T. Bondurant French, Executive Chairman, Adams Street Partners

In reflecting on the changes in the private equity industry over the last 45 years, fundraising trends were one of the first things that stood out. Looking at fundraising data for the private equity industry, I was a little taken aback to see that 1960 through 1983 were barely visible on my bar graph, compared to the funds being raised today. In 1972, $225 million was raised for venture funds in the US; buyout funds didn’t exist and Kleiner Perkins was a first time fund. Venture fundraising bottomed in 1975 at $60 million.

By 1979, the economy was better, capital gains tax rates had been lowered from 50 % to 28 %, venture-backed companies were bounding (Intel, Microsoft, Apple, and Genentech), and $800 million was raised for venture funds. In the early 1980s, venture funding really took off on the back of excellent returns and a rising stock market. In 1983, $3.7 billion was raised and for the first time the term “mega fund” was used.

It is hard to imagine today, but we had no real data to evaluate the managers with and there were very few realized deals. Almost everyone was a first time fund and there were virtually no formal standards in place. Benchmarks, quartile rankings, written valuation guidelines, and placement agents did not exist. Neither did industry conferences and newsletters, with the exceptions of the National Venture Capital Association’s annual meeting and the Venture Capital Journal. The fax machine hadn’t yet been invented, but a new venture-backed company, Federal Express, helped us with overnight documents.

Back then, fundraising was exceptionally difficult. Most pension consultants did not follow or cover the asset class. We spent a lot of time doing educational presentations for trustees and their consultants at offsite retreats, board meetings and pension conferences. During the 1980s, our hard work finally began to pay off. As we had actual data going back to 1972, we became pension funds’ source of information on expected returns, standard deviations and correlation coefficients for the private equity “asset class.” The new term “asset class” implied a transition from a niche activity to something that was becoming institutional. We took the lead in establishing the first industry performance benchmarks, chaired the committee that established the private equity valuation guidelines, and worked with the CFA Institute to establish the guidelines for private equity performance reporting.

Throughout the 1970s and for most of the 1980s, we had lived in a US and venture-centric world. Now, the buyout business was emerging as a new practice within the world of private equity. Pioneered by KKR, CD&R and a handful of other firms, the use of leverage to buy and manage a company was a new idea. The development of the high yield bond market, led by Michael Milken of Drexel Burnham Lambert, made this practically possible on a much wider scale than previously thought. Heretofore, “junk bonds” were formerly high grade bonds of companies that got into trouble and were in or likely to be in default. The idea of a new issue “junk bond” was a new concept.

In 1980 only $180 million was raised for buyout funds in the US. This grew to $2.7 billion in three years, and $13.9 billion by 1987. As with many things in the financial and investment markets, this was a good idea carried to an extreme, culminating in the takeover of RJR Nabisco in 1989 by KKR (as told in a book and a movie, both called Barbarians at the Gate).

During the second half of the 1980s, managers in Europe and Asia began to adopt “American style” venture capital and buyout practices. Many of these managers made fundraising trips to the US as, relatively speaking, there were more willing investors there. Along with pension funds and endowments, nearly all of the private equity funds of funds were based in the US.

By 1990, the US was in a recession and a savings and loan crisis. Buyout fundraising dropped dramatically, with only $6 billion raised in 1991. Fortunately, lessons were learned by all parties and the buyout business grew steadily and more rationally throughout the 1990s. What were originally highly leveraged transactions morphed over time to become today’s private equity industry, which provides a variety of equity capital, including growth capital, to a broad range of industries and businesses.

By the mid-1990s, the globalization of the private equity market was on the horizon. A number of venture and private equity managers were becoming established in emerging markets. By the mid-2000s, institutional investors were interested in global exposures enhancing their diversification and return potential by accessing rapidly growing economies. Significant money was raised by Asian general partners, particularly in China. Fast forward to today, the private equity industry has expanded to nearly every corner of the globe.

While many things about the private equity industry have changed over the last 45 years, several things remain the same. Private equity remains a people business and, at Adams Street, we understand that the people we invest with are of paramount importance. Spending time with them is an important part of developing real relationships based on trust and mutual respect. Nothing has changed in that regard and these relationships are a critical part of our investment process. The characteristics of successful private equity firms are the same today as they were decades ago. It takes mutual respect, independent thinking, and an optimal mix of experience and energy. At the heart of all enduring firms are good investors who have time to work with their companies, an international awareness and network, and a differentiated deal flow edge.

I am very proud of what the private equity industry does. We generate above average returns for our investors while also providing capital to finance business growth. This financing cuts across a wide spectrum of company stages, industries, and geographies. The end result is greater growth in job creation, wealth, and GDP than would otherwise be possible.