If you have decided to start a private equity fund, hopefully you have
taken some time to consider how you will be compensated for managing the
fund and making successful investments.
Following are some of the more common fee structures used by sponsors of
private equity funds:
- Management fee: The management fee is commonly charged as a percentage
of assets under management, and is usually between 0.5% and 2%. First-time
hedge fund managers usually try to minimize or eliminate the management
fee in order to align their interests with those of the fund investors.
- Performance fee/carried interest: Private equity fund sponsors often receive
a performance fee that is calculated as a percentage of the fund’s
profits or gains. The manner in which the fee is calculated and the frequency
in which it is paid depends on the fund’s underlying assets. If
the fund’s underlying investments are expected to pay significant
dividends, then the general partner of the fund may be paid a performance
fee at the same time that the dividends are paid. More commonly, the performance
fee is paid when the fund’s underlying assets are sold. The amount
of the performance fee is usually at least 20%, and can be greater if
no management fee (or a low management fee) is charged. The performance
fee is usually paid as a “carried interest” in the fund, which
permits the general partner to pay capital gains tax rates on the carried
interest, rather than at ordinary income rates.
- “Waterfall” fee: In a waterfall structure, the investors in
the fund receive their initial investment back first (plus sometimes,
a stated rate of return) before any fees are paid to the general partner.
An example of this would be the investors receiving 125% of their capital
contributions, then an allocation to the general partner of 20% of the
amount of any gain. Any remaining gain is then allocated to the investors.
Note that the ability to charge a performance fee depends on the state
in which the general partner is located, if your private equity fund has
less than $150 million in assets under management. For funds smaller than
this amount, it may not be permissible to charge a performance fee to
investors that are not considered “qualified clients” under
There are many important legal issues to be considered when forming a private
equity fund, including the fee structure. If you are ready to form your
private equity fund, contact Whitley LLP Attorneys at Law today. We can
help you navigate the complex legal issues involved and help your fund
get off to a successful start.