Private Equity Portfolio Company Fees
Ludovic Phalippou, Christian Rauch, and Marc Umber (2016)
Research Retrieved: May, 2016
When private equity firms sponsor a takeover, they may charge fees to the target company while some of the firm’s partners sit on the company’s board of directors. In the wake of the global financial crisis, such potential for conflicts of interest became a public policy focus. On July 21st 2015, thirteen state and city treasurers wrote to the SEC to ask for private equity firms to reveal all of the fees that they charge investors. Since 2015, the SEC has been fining a number of private equity fund manager for such practices.
We show that it is possible to obtain comprehensive information about the portfolio company fees charged between 1995 and 2014: we examine 25,000 pages of relevant SEC filings covering 1,044 GP investments in 592 Leverage Buy-Out transactions, whose total enterprise value, including add-on acquisitions, sum up to $1.1 trillion. The sum of the transaction fees in our sample is $10 billion, and monitoring fees sum to a similar amount. Other fees (e.g. refinancing fees) add up to $2.4 billion. In total, these portfolio company fees add up to nearly $20 billion, representing 6% of equity invested, and are basically equally distributed over time. These fees do not cover the cost of doing business as these costs are refunded separately by portfolio companies; they are ex-post discretionary fees paid irrespective of work effectively carried out. Managers that charge the highest fees tend to be outliers, small, young, and raise significantly less capital going forward. Market forces seem at work although they seem to have taken two decades to manifest themselves.
Transparency of (and insight in) the costs associated with private investing (private equity in particular) is an important topic. The regulatory intervention is benefitting institutional investors who invest in private equity funds and fund-of-funds. But it also raises the question how large pension funds’ in-house private equity departments deal with charging fees to target companies.