Private equity firms and Hedge funds charge annual Management fees. Management fees are set as a percentage of the capital invested and they are used to cover the day-to-day operation of the fund including salaries, professional services, and general and administrative expenses.
Funds usually also ask for success fees. Success fees are not aimed to cover operational costs but are aimed to align the interests of the managers with interests of the investors.
Hedge funds and private equity treat Management fees differently.
Hedge funds have one pool of capital that they manage actively and constantly so they usually have one set of management fees for the life of the investment. For example, a hedge fund might charge 2% of the invested capital. Hedge fund management fee’s structure is like the mutual fund management fee structure.
Management fee at private equity firms varies from firm to firm. Some might have a simple structure like hedge funds – a straight, stable percentage throughout the life of the investment. Some private equity funds change the percentage of management fees during the different stages of the fund’s life cycle. A private equity firm has three main periods:
– Commitment period – When investors sign a subscription agreement, they commit to transfer capital when the fund issues a capital call. The fund will call the capital when they are ready to make investments. The commitment period can last a few months and even a few years. This practice is done to increase total performance of the fund.
– Investment Period – In this period the fund managers seek investments.
– Harvesting realization period – In this period fund managers follow the investments, help improve performance and seek opportunities to sell and liquidate the assets.
Managers might set a different management fee for each period:
– Commitment period – Management fee can be set as percentage of commitment amount or of capital called. For example, commitment amount can be $100,000 and the capital call can be $40,000. Management fee can be set as percentage of the $100,000 commitment or of the $40,000 capital called.
– Investment Period – This is the usually the busiest period of the fund. Management fees will be at the max rate. Some managers will also charge an Acquisition fee. For example, a real estate private equity firm might charge an Acquisition fee when they close a deal.
– Harvesting realization period – Managers are not actively seeking investment and the fund might be less active. Some managers might ask for a reduced amount of management fees.
Each manger will choose the management fee that best meet the structure of the fund’s expenses. Examples of management fee structure:
– 2% of commitment capital.
– 2% of committed capital until the end of the investment period. Management fee will be reduced by 10% each consecutive year thereafter.
– 1.5% of called capital + 2% Acquisition fee.
Manger might consider a discount for large investors. Large institutional investors are increasingly more sensitive to management fee structures, and they negotiate the fees with the managers.