By: Carmela Mendoza PUBLISHED: 23 November 2020

INVESTORS Flexible fee structures: Should you consider one? Hamilton Lane’s dual fee structure for its latest co-investment vehicle shows how GPs are responding to changing investor preferences

Lower management fees and alternative return management”, opting for invested “A conventional PE fund usually has carry structures are among ways GPs have capital models and are thus willing to pay a stable drawdown of management fees. attracted LP commitments over the years. more for performance. It can also have lumpy drawdowns for Hamilton Lane’s latest move – offering Its prior four funds have had a acquisitions, but a GP is not going to classes on the basis of traditional 1 percent management fee on make all the acquisitions on day one – it invested capital – is an unusual one. committed capital, which then switched will make those at intervals across the On the firm’s latest earnings call in to a 1 percent fee on net invested capital investment period,” said Silveira. early November, vice-chairman Erik after the investment period. Carry was at He noted that an infrastructure fund, Hirsch said it was offering a dual fee a 10 percent rate over an 8 percent hurdle, on the other hand, might expect to call structure for its latest direct equity fund. Hirsch noted on the call. and deploy most of its committed capital Investors in Hamilton Lane Equity Hamilton Lane declined to comment relatively quickly, which would give it Opportunities Fund V can either pay a beyond details of its earnings statement. higher levels of invested capital fairly early traditional 1 percent management fee International spoke with in its long life – so the benefits for LPs of on committed capital with 10 percent industry practitioners on the implications paying fees on invested capital (as opposed carried interest or a 1 percent fee on of offering a fee structure on invested to committed capital) would be less invested capital with 12.5 percent carry. capital. Here’s what we found. pronounced for that kind of fund. The hurdle rate remains at 8 percent, as Firms that have offered LPs fee does the European waterfall methodology, The investment strategy matters optionality before – although on Hirsch said. Charging management fees on invested committed capital – include KPS Capital The firm held a first close for the capital is less common in a blind- Partners and . Pantheon, vehicle on $320 million in October. Of pool private equity fund, including a meanwhile, blended the management fee investors in the first close, 67 percent co-investment strategy, than in other and carried interest into one performance- opted for the invested capital and higher alternative asset classes, according to legal based fee, as an option for its private carry option, he added. experts. equity strategies targeted at the defined Hirsch said the firm altered the fee Infrastructure funds, for example, often contribution market. model to reflect “changing investor use invested capital as their base for fees, preferences”. LPs were also becoming according to Mark Silveira, a funds lawyer Quick deployment is a factor “more focused on early internal rate of at MJ Hudson. The real difference between using a

Reproduced with permission from privateequityinternational.com traditional committed willingness to take a potential hit on performance” via the carried interest, rather than on invested capital is how management fees in exchange for higher rather than being burdened by what they quickly a GP can invest the fund, industry carry also highlights how well the firm believe to be high fees incurred in the practitioners noted. GPs that anticipate believes it can perform. early years of a fund’s life cycle, is also deploying capital quickly would be advantageous. less impacted by a management fee on It really is about alignment It’s unclear whether more managers invested capital. Matthew Goldstein, a partner at Paul, will follow suit In many cases, GPs model it out – Weiss, Rifkind, Wharton & Garrison, While the two-and-20 fee structure has based on target returns and anticipated noted that GPs can garner goodwill with been challenged over the years and the holding periods – such that they are LPs by showing flexibility on fees and headline management fee rate for most relatively neutral as to which fee option seeking to align interests with LPs. funds is now between 1.5 percent to 1.75 investors elect, said Alex Amos, a partner In Hamilton Lane’s case, its co- percent, it is unclear whether Hamilton at Macfarlanes. investment funds series provides direct Lane’s move will be adopted by the wider While it is clear that a management equity capital into and growth market. fee on committed capital provides a more transactions alongside GPs, attempting to By offering to change the management steady and reliable revenue source than a reduce the fee burden for LPs. fee basis to invested capital in exchange management fee on invested capital, Amos Goldstein added that GPs who for higher carry, the management team is noted there is potential for greater overall proactively offer more creative fee in effect doubling down on its ability to fee revenue for the GP with the lower discounts upfront might be able to raise achieve stronger returns, Silveira pointed management fee/higher carry option, capital quicker than normal, allowing out. And funds that are oversubscribed given that in theory there is no limit to them to direct their attention to deal are not under pressure to alter their fee the level of outperformance in a private sourcing and execution. models, he added. equity strategy. LPs, meanwhile, also benefit as they Management fees continue to be Hamilton Lane’s co-investment are able to justify to their respective a major point of friction between vehicles – contrary to a traditional PE constituencies committing dollars to investors and their managers, as PEI’s LP fund – are not limited to a specific strategy funds quickly and at scale if they can show Perspectives 2021 survey – published in or geography. In fact, the investment that the fee rates are highly competitive December – examines. Still, initiatives universe can be “as wide as wanted”, relative to market, according to Goldstein. such as Hamilton Lane’s appear for the according to a statement. Hamilton Lane’s To show that LPs are “paying for time being to be rare. n

Reproduced with permission from privateequityinternational.com