How do private equity firms and it’s partners make money?
How do Private Equity Firms and its partners make money?
Who are these GPs that we discussed in our last video (Video #4)? They are the private equity firms. Some of the largest private equity firms in the world are Carlyle Group, TPG, KKR, Blackstone and Apollo.
Private equity firms make money primarily through two sets of fees: management fees and performance fees.
Management fees are a percentage of assets which are meant to cover office rent, employee salaries and other types of day-to-day expenses.
Traditionally,in private equity, these fees have been 2% of assets. As private equity firms have grown (and continue to grow) larger, management fees for the mega funds decreased below 2%.
In venture capital, the smaller funds might have management fees higher than 2%.
The second type of fee is a performance fee, also known as carried interest or “the carry”. This fee is used to compensate the GP for its performance. Occasionally, there is a hurdle rate which guarantees the investor be paid a fixed amount before the GP can get any part of the fee (the performance fee is typically 20% of the upside).
Let’s look at an example where we have a performance of 20%, a hurdle rate of 8% and a GP catch up clause. The first 8% of performance will go to the LP; the next 2% will go to the GP. The remainder of the returns will be divided 80% to the LP and 20% to the GP.
With a 2% management fee and a 20% performance fee, the private equity fund is said it to be charging “two and twenty”. In addition to management and performance fees, we also have other various small fees such as transaction and/or monitoring fees.
Through all these fees, the founders of these top private equity firms have made quite a lot of money. In fact, many private equity founders are billionaires that have done some great things with their money.
Among his many donations, Steve Schwartzman from Blackstone has given $150 million to Yale University as well as $100 million to the New York public library to fund renovation and expansion.
In addition to many other projects, Henry Kravis from KKR has given $125 million dollars to the Columbia Business School and a $100 to the Memorial Sloan Kettering Cancer Centre to fund cancer treatment and research.
And, finally there’s David Rubenstein from The Carlyle Group. Rubenstein signed the Giving Pledge that was originated by Bill Gates and Warren Buffett encouraging wealthy individuals to give away half of their earnings, either during their lifetime or through their will. With a net worth of almost $3 billion, David Rubenstein is going to be doing a lot of giving!