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Compensation of General Partners of Private equity funds

Compensation of General Partners of Private equity funds

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Published by Manu Midha
This paper introduces the basic concepts relating to compensation of General partners of Private equity funds.

A basic note, with very little pre-requisites to be able to understand.
This paper introduces the basic concepts relating to compensation of General partners of Private equity funds.

A basic note, with very little pre-requisites to be able to understand.

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Published by: Manu Midha on Nov 10, 2009
Copyright:Attribution Non-commercial


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Note on Compensation of General Partners in theVenture Capital and Private Equity Industry
By Manu MidhaAbstract:
The article defines various components of the total compensation of General Partnersin a VC / PE setup (which could be a partnership or a private limited concern). It talks about some of the recent trends in the industry and what determines the exact compensationstructure.The article may reflect some of the biases held by the author, and one is free to agree/disagree.Comments and suggestions are welcome. No character/fact in this note is fictitious.
- General Partners of a PE/VC fund are the managers of the investing entity. They are theones who raise capital, identify and evaluate investment opportunities, make investments andfinally exit them and return the capital back to the investors. Most of them also co-invest withthe LP’s in the fund, but normally their investments are limited to around 5% of the total size of the fund.
- Limited partner of the PE/VC fund, the investors to the PE fund. These are called ‘Limited’,as their roles are limited to making investment to the fund and not in the general managementof the fund. They typically meet at periodic intervals to monitor and discuss investments madeby the fund.
For the purpose of this note, we will assume a WIMWI PE fund, of 10 year life andsize $1Billion, managed by a team of GPs headed by ‘Maacho’ ji, and invested into by a team of LP’s represented by ‘Nacho’ ji (doesn’t he look like one?, believe me he has a big portfolio!!).
Figure 1: Structure of a typical PE / VC FundIntroduction
Executive compensation has been a topic for much debate off late. There have been severalreports published on compensation of executives working with banks and other financialinstitutions. Not much has really been said about compensation of General partners in Privateequity (and Venture Capital) firms. This is not really because they are less paid than the formeror because most of this industry (PE/VC) moves with a lag to the actual financial markets, butbecause there were fewer funds being raised and new compensation plans being published off late.
Limited Partner(Eg. Fund of funds)Limited Partner(Eg. Univ. Endow.)
Limited Partner(Eg. Pension Fund
Invest ($$) Invest ($$)General Partners[The PE Firm](Partnership/Pvt. Ltd. Co)Manage andCo-Invest ($$)
PortfolioCompanyPortfolioCompanyPE/ VC Fund (The WIMWI PE Fund)
Receive Investments($$) ($$) ($$)($$)
GPs reresented b ‘Maacho’iLPs reresented b ‘Nacho’i
In our Current Illustration:
Demystifying Compensation of GP’s
There are three basic ways in which General Partners are compensated. These are:
1. The fund management fee:
Also called Management fee, this is an annual fee and isnormally a fixed percentage of the total capital committed during the investment period andsometimes a fixed percentage of unrecovered capital thereafter.
Committed capital 
is the amount of money that the LP’s have paid cumulatively upto thatpoint. The industry standard is about 2% for Venture funds (smaller) and about 1% for larger PEfunds.
Unrecovered capital 
is the part of the fund that is not paid by the LP’s as yet. Not all money ispaid upfront by LP’s but is paid in installments.
Illustration 1:
Say for our WIMWI Fund the LP’s, led by ‘Nacho’ji, have committed to pay $ 1 Billion over 5equal installments in 5 years (4 – 5 installments is the norm) i.e. $ 200 million per installment.Let us also assume a 2% fund management fee to be paid to ‘Maacho’ji and group.Therefore, for the first year the Fund management fee amounts to $4 million (2% of $200million) for the second year it would be $ 8 million and $ 12 million for the third year and so ontill it reaches $ 20 million in year 5. (Remember fund management fee is a percentage of thecumulative capital paid by LP’s).Now after year 5, it stays constant at $ 20 million per year for the last 5 years.This fee is normally used to cover the fixed expenses of the fund, eg. salaries, office rent, etc.
Exceptions from the illustration:
This may be calculated annually / semi-annually or quarterly based on the pay-in structure of the fund.

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