🛠️ Investment Fund Key Terms, Part 22

🎉 Happy Friday, funds family!

Today, we have Part 22 in our many-part series walking through each term in an investment fund term sheet in detail.

Here’s the index of each article in this series (so far):

• Part 1: Naming your entities

• Part 2: Investment objectives

• Part 3: Fund size

• Part 4: LP minimum check size

• Part 5: GP commitment

• Part 6: Fund term

• Part 7: Fundraising period

• Part 8: Investment period

• Part 9: Capital recycling

• Part 10: Investment limitations

• Part 11: Leverage Limitations

• Part 12: LP Withdrawals

• Part 13: Key Person Event

• Part 14: Successor Funds

• Part 15: Carried Interest

• Part 16: Preferred Returns

• Part 17: GP Catch-Up Provisions

• Part 18: American vs. European Waterfalls

• Part 19: Split Waterfalls (Cash Flow / Dispositions)

• Part 20: Carried Interest Clawbacks

• Part 21: LP Giveback

This week focuses on Management Fees.

The management fee is a recurring fee paid to the manager of an investment fund or syndication. 💸

It sounds simple, but there are many ways to calculate (and reduce) the management fee. GPs and LPs alike should understand how management fees actually work.

➡️ What are management fees?

The management fee is a recurring fee (usually paid quarterly, but sometimes monthly) paid to the manager of an investment fund or syndication. It is typically paid to the Management Company entity (not the GP entity that receives the carried interest).

The management fee is intended to cover Management Company overhead, such as salaries, rent, compliance costs, and sponsor-level accounting.

➡️ How are management fees calculated?

Management fees are always an equation:

BASE × PERCENTAGE

💲 Percentage: Typically between 1.0%–2.5%, with the majority falling between 1.5%–2.0%.

💲 Base: Typically committed capital, invested capital, NAV, or gross income.

Too many investors focus on the percentage without fully appreciating the base…but the base can make a huge difference!

➡️ What’s a “normal” management fee?

“Normal” depends entirely on asset class.

Venture funds: often (i) 2% of commitments during the investment period, and (ii) 1.5% of commitments thereafter.

Private equity or real estate: often (i) 2% of commitments during the investment period, and (ii) 2% of invested capital thereafter.

Hedge funds: often 1.5-2% of NAV.

➡️ Step-downs are common

After the investment period ends, many funds reduce the management fee. In venture funds, the percentage usually steps down. In other closed-end funds, the percentage usually stays the same but the base downshifts from committed capital to invested capital.

The rationale is that the fund manager does more work during the investment period, when they are diligencing and making new investments.

➡️ Management fee reductions

Various items may reduce the management fee, including placement fees paid by the fund, excess organizational expenses (over a negotiated cap), or offsets for other fees earned by the sponsor.

In addition, GPs may elect to waive a portion of the management fee in exchange for a profits interest in the fund. This is essentially a mechanism for funding a portion of the GP commitment to the fund or syndication.

➡️ Fee discounts

LPs may be able to negotiate management fee discounts via side letter. GPs: only do this for large or strategic LPs.

GPs may also proactively offer fee discounts to investors who commit larger amounts of capital or who invest before a specified deadline.

⏩ Next up in Part 23: Fees Paid to GP Affiliates

Thanks for reading, everyone.

Have a great weekend! 🙌 

⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This newsletter may be considered attorney advertising.