The changing structure of PE management fees in investor transactions is forcing GPs to be more accountable, more nimble and more flexible in their use of experts. With the traditional 2/20 fee structure under increasing pressure, firms that make greater use of freelance expertise are driving bigger returns for LPs and GPs alike.

‍Some of the pressures we see on PE management fees include:

Limited Partners Are Starting To Look & Act Like Direct Investors.

‍For years, Limited Partners have had a rigid 2/20 fee imposed upon them . Typically, those come without performance guarantees. But this was the old way of doing things. Today’s crowd-sourced, Web 3.0 environment has shown them other options. They want more flexibility in deals, and lower fees. Many have begun hiring direct investment staff and are starting to look and behave more like General Partners. Some Limited Partners have begun co-investing alongside private equity firms in order to avoid the traditional fee structure, typically paying a 1.0% management fee and 10% carried interest on co-investments. These trends are expected to intensify as Limited Partners continue to develop in-house direct investing expertise and become more selective in their capital allocation.

‍Increased regulatory enforcement by the SEC

‍We cover this in a separate post, but we’ll just say that the pressure is on from regulators to more accurately apportion and disclose management fees vs. operating costs. With the old fee structure facing this much resistance, there’s a real advantage to hiring domain experts on a project-by-project basis to support individual transactions. An approach like this has a dual benefit:

(1) It keeps overall HR costs low because the resources can be scaled as and when there is deal flow, and

(2) You can improve the depth and breadth of your investment team.

‍

At Graphite, we are seeing more and more investment firms adopt this specialist approach. They’re hiring sector experts to help execute transactions on a deal-by-deal basis instead of maintaining large teams of generalists. Investment firms are also encouraging their portfolio companies to tap into flexible talent such as freelance investment bankers, consultants, industry experts and interim CFOs in order to support capital raises, add-on acquisitions and other strategic initiatives. This leaves in-house investment staff free to focus on deal execution, and lowers the management costs that are passed on to LPs.