What kind of management fees are charged in private equity? Like most terms of a private equity placement memorandum, management fees come in all shapes and sizes. In private equity, there is a general rule of "2 and 20" - a 2% yearly management fee (usually paid quarterly) plus a 20% carry.
Now the lifeblood of private equity and asset management is fees generated on assets. A firm needs money to pay the GPs, the associates, the secretaries, the rent, and all their bills. They also need money to pay for due diligence and professional and legal fees. A 2% management fee is pretty standard. If you think about a $100 mm fund that is $2 mm per year. Now imagine a $500 mm fund and you can start to see that $10 mm is a good chunk of change. Also consider that the firm may runs several funds concurrently and your eyes are certainly starting to bulge - No wonder why everyone wants to get into private equity.
One thing that you should know is that the management fee is not static throughout the life of the fund. Throughout the life of each fund, there is an "investment period" of active investment. In a buyout fund this typically is a 4 or 5 year period after the fund commences. After the investment period has ended, the fund legally is not allowed to make new investments, it should be spending the remainder of the fund duration (funds are usually ten years long with a few one year extensions) harvesting its investments for liquidity. So during the investment period the management fee will usually be around 2% then it will get reduced, sometimes down to 0.75% or 1%. In some crude sense, the firm is trying to be fair to its LPs by charging less for basically doing less.
While a 2% management fee is standard, it isn't universal. In venture funds, the management fee usually runs a little bit less, like between 1.5% and 2% per year. Granted, like the carry, the management fee will also vary according to the reputation and desirability of the firm. I have seen management fees as high as 3% and as low as 0.5% on a fund of funds. I recently saw a 2.5% carry on a buyout fund focused on Europe.
If you are an investor in a fund, the management fee is important because it reveals the underlying philosophy and motivation of the GP. This is for several reasons. First, at the end of the fund, the return and multiple of the fund is calculated as net after management fees. In other words, on paper the management fee goes against the fund return. So the returns from the fund must be high enough to significantly eclipse the management fee. If a firm charges a high management fee then it may suggest that the GP is confident the the fund will produce an outsized gain. On the other hand, why wouldn't the firm charge a lower fee so that its fund would have a higher return?
The second reason why the management fee structure is important is that it is an easy way to tell whether a firm is aligned with its investors. There are some firms that charge a reasonable management fee and then when the profits come they pay back those fees from their carry. Apparently Silver Lake and NEA do this. My feeling is that if you can find a good firm that has this policy, put your money with them because they are well aligned and you know that your management fees went to pay for fund operations and performance, not hefty GP salaries.
As both an investor and a fund manager, I don't like high management fees. In every job or activity, people should always get rewarded by their performance. You can't sit on your laurels and get paid the big bucks. A firm should get rewarded by its return through the carry. The bigger the return, the bigger the carry. A firm shouldn't make money unless its investors do.
Once again, I welcome any comments or questions.