Private equity firms make money in a number of different ways, including through charging management and advisory feeds, selling businesses for a profit, and dividend recapitalisations.
1. Management fees
PE firms charge each of their investors an annual management fee. This fee is typically 1% - 2% of the assets under management (or “AUM”), meaning the total amount of capital committed by each investor, including any portion of the capital committed that hasn’t yet been paid to – or invested by – the PE firm. Management fees are there to cover the PE firm’s operational expenses, salaries and overheads, and must be paid regardless of the fund’s performance.
2. Advisory fees
Post-investment, PE firms may occasionally charge its portfolio companies advisory fees to cover the day-to-day costs involved in monitoring, advising and helping to grow those companies.
3. Fees based on fund performance
If the overall value of a fund performs well - for example as a result of the PE firm selling portfolio companies for a profit - PE firms will be entitled to a percentage of the gains. This is referred to as “carried interest” or “carry”.
In simple terms, a PE firm will typically be entitled to keep around 20% of the fund's profits, provided that the fund hits a pre-agreed threshold of profit (this threshold is often referred to as the “hurdle rate”, and is typically 7% - 10%). In practice, the phrase “2 and 20” is often used to describe the fee structure of 2% management fees and 20% of the gain.
4. Dividend recapitalisation
PE firms may also occasionally arrange for portfolio companies to take on debt, then use some of the cash borrowed to pay out special dividends to their investors. This reduces risk for investors, who consequently recoup part of their initial investment earlier on. However, it can reduce the financial stability of portfolio companies - given the increased debt to equity ratio - meaning dividend recapitalisations aren’t particularly popular among creditors and other shareholders.
", "video_url": "https://www.commerciallaw.academy/api/course_player/v2/contents/56600428/play/11418444", "attachment_ids": [], "download_file_ids": [] }, "attachments": [], "download_files": [], "videos": [ { "id": 11418444, "storage_location": "videoproxy", "identifier": "cq64ss2uhpqs72piu6a0", "primary_thumbnail_url": "https://embed-ssl.wistia.com/deliveries/59421a63d71ab54ca1fe0da842699e1300138146.jpg", "encoded_state": "finished" } ] }