Course: monitoring and arrangement fees

Private equity fees for monitoring and arrangement

Training course provider: The fee arrangements that we have talked about, that are agreed between the investors, are really quite transparent, all right. As an investor in private equity I know I’m going to pay an annual management charge, and I know the individuals involved are going to get a handsome bonus if they do well for me. One of the other things, David, that private equity firms do is… is charge other fees – not to the investors, but direct to the companies – to the portfolio companies. So here we go; we’ve got this slide here – its slide ten in your packs, and what we can see already on that list is a couple of the fees that we’ve talked about. The management fees, Ollie, that we talked about, the carried interest bonus arrangements as well. Number one for the management fees; four for the carried interest. Those are agreed with the investors and are really quite clear.

Private equity monitoring and arrangement fees

Training course provider: In the article, David, what was the fee that it was talking about? Did it name what sort of a fee it was?

Delegate: It was mentioning monitoring fees.

Training course provider: It mentioned monitoring fees.

Delegate: And advisory fees.

Click here to access the article being discussed: private equity: the fundamentals

Training course provider: And advisory fees, all right. So in that article it talks about monitoring fees; that’s category number three and category number two. Now a monitoring fee would be an annual fee which is paid by the portfolio company to the private equity executives. Now you’re looking a little bit perplexed, David; why are you looking perplexed?

Delegate: I was just wondering what right do the private equity house have to charge those fees?

Training course provider: What right do the private equity house… have to charge the company? Look, I’m with you, David, because I, you know I used to work in corporate finance; you work in corporate finance, and I’m thinking these guys are going to be investing on the expectation they’re going to make a handsome reward. Their argument will be on these monitoring fees: “That’s to compensate us for the time that we’re going to spend helping your company grow”. That doesn’t really… that probably doesn’t help you, David, and it probably doesn’t help me very much as well; because I’m thinking hang on a minute… hang on. Yeah, the whole point is you’re going to help this company grow and that’s how you’re going to gain… so why’re you going to charge?

Well let’s try… I’m going to try and make it more palatable for you – and I’m not sure I can – all right, the monitoring fees, let’s look at it this way. David, if I was… if I’m imagining I’m the private equity guy and I said to you: “Well actually, David, it’s not going to be one of our staff members who’s on the board, it’s going to be a thi… a very credible third-party individual and he’s going to have his own costs, so it’s just to make sure those costs are covered’; is it making it slightly more palatable?

Delegate: The person who’s been put on the board would have been put on there because they can generate the returns.

Training course provider: …I take your point. He’s working for private equity and, OK, all right, I… we’re not going to get too far on this.

Delegate: Let’s put it another way. In normal equity, as a shareholder… you know if I bought shares in Barclays I wouldn’t charge Barclays.

Training course provider: That’s right, if you made an investment in any other company you wouldn’t charge the fees for having made the investment.

Training course provider: I tell you, David; you and I are not going to get too far on this. I suppose… I suppose what it’s going to boil down to, David, if we’re playing hardball now – we’re just pretending – David, it’s market practice.

Delegate: Yeah.

Training course provider: Every other private equity firm does it, and so we’re going to do it as well. It’s market practice. But you can see even if I can get the market practice argument past you, you’re seeing from that article there that there are some investors who are kind of on your side who are saying, you know: “Hang on a minute, these monitoring fees are just an excuse for the private equity firms potentially to rape the company without us even knowing about it”. All right. So that is one of the controversies at the moment.

Private equity arrangement fees

Training course provider: The arrangement fees – let’s understand this one, and I don’t think David, you and I are going to get very far on this either, because I think the same sort of arguments are at play. The arrangement fees are – you guys work in corporate finance, and this is very similar to an M&A type fee. So very similar to an M&A type fee… and maybe the argument here is if we’re talking about market practice, if I’m imagining I’m the private equity firm, Matt, what I’m saying to you is that the banks are going to charge an arrangement fee on their loan, so as a private equity firm we’re going to charge an arrangement fee on our equity. Fair enough?

Delegate: To the portfolio company?

Training course provider: To the portfolio c… essentially it gets charged to the deal or the portfolio company, not direct to the investors. So of some of the money that’s going in to the deal, some of that original twenty – David’s again looking perplexed and I understand why – some of that twenty that’s going in, a chunk of it straightaway – maybe it’s one percent, maybe it’s as high as two percent – of that twenty is going to go straight back into the pockets of the private equity firm. What’re you thinking about that, David?

Delegate: I want to be working in private equity!

Training course provider: You want to be working in private equity! Well we know that that industry is… is having hard times at the moment; it’s under pressure in all sorts of areas, and investors are putting pressure on the private equity firms; you can see that from this article – don’t like the arrangement fees, don’t like the monitoring fees.

Delegate: Is the arrangement fee charged to the fund or the actual deal?

Training course provider: Well the way it… the way it would… the way it would work… Matt, what were you going to say?

Delegate: That it’s part of the deal costs.

Training course provider: It’s part of the deal costs, and we’ll see it… actually we’ll see it, because we’re going to, in the next session, build up a sources and uses of funds. But if you like, the private equity firm, instead of going to the… instead of going to the investors for – I’m just making up the numbers – nineteen million of equity. Instead of going to the investors for nineteen million, most of which is going to go across to the seller of the business, they have to go for twenty because there are fees on the deal; one of those fees is their own… the fee that they charge; that they charge. You’re looking perplexed, and you’re right to look perplexed, and I think that there’s a few investors that are perplexed; and the whole… probably the issue here is that investors are worried about these things being sort of hidden, and what they want is the private equity firms to be open with them and… and they want to know to what extent this is going on; how big are the monitoring fees? How big are the arrangement fees? Can we keep that in their box?

If we’re summarising up with the pressure on private equity firms, perhaps some pressure on these monitoring and arrangement fees that we’re seeing in those articles there; there’s one other main area of pressure I think. What’s the other area where they’re coming under pressure from the investors?

Delegate: On the management fee.

Click here to access the article being discussed: Wave of dissent against high buy-out fees

Training course provider: On the management fees themselves. And there… I think there was one investor there saying: “I want to be sure that those management fees…”; really he was saying that “I don’t want those management fees to be so high that the private equity firm doesn’t have to worry anymore”. And they were doing a calculation, weren’t they? They were taking the management fees, dividing them by the number of people. What was the figure that stuck in your mind? It stuck .in mine as well. Seven million. So they had one case where the private equity firm was potentially – on management fees alone – this is the… this is… Ollie, this is the sales person’s base salary; on the base salary alone, the base salary alone was seven million pounds per person per year. That’s… would you have to worry if you were earning that kind of base salary, about your bonus, Ollie?

Delegate: It wouldn’t necessarily motivate you very much.

Training course provider: It wouldn’t. You’d have problems with your motivation, wouldn’t you? You would. And that’s what investors are worried about as well. OK.

Delegate: I’d be very motivated to buy a boat and sail it round the world.

Training course provider: Very motivated to buy a boat and sail it round the world perhaps, yeah. Any other questions about those fees? A couple of surprises there, touching on some controversies. Questions about the fees and fee arrangements?

More private equity training course material

Next the introduction to private equity course considers tax rates for industry executives.