Private equity fund fees don't reflect benefits of scale
While larger private equity funds generally have lower management fees than their smaller peers, these lower fees don't fully reflect the economies of scale enjoyed by the bigger firms. As a result, the operating economics of the largest funds are very favourable, and the management fees they earn have become a significant source of income.
This was one of the findings of a survey published yesterday by London-based information provider Preqin and Chicago-based compensation consultancy FPL Associates.
Consequently, and particularly in light of the current economic climate, there is pressure from investors on the larger funds to reduce the management fee rates for new vehicles looking to raise capital, says the survey.
Investors are seeking to bring management fee levels more in line with funds' running costs. The report cites as evidence for this the fact that the biggest drops in management fees for the most recent buyout funds have come from among the largest funds.
Looking at the fees issue in more detail, venture and buyout focused firms employ the largest number of people, with each sector accounting for around 30% of the total. This is despite the fact that buyout firms manage well over twice the amount of assets as venture firms, says the report, suggesting that large private equity firms clearly benefit from significant economies of scale.
As one would expect, the average number of employees rises as the size of the firm increases. However, the average number of employees per $1 billion in total assets falls progressively as firms increase in size, says the report. The smallest firms have, on average, one employee for every $7.7 million in total assets, while firms with $10 billion or more have an average of one employee for every $100 million managed.
Moreover, the survey shows that the favourable operating economics of the largest funds have an effect on employee pay to some extent. For example, the average remuneration for a managing general partner of a private equity firm in the smallest size group in the survey's sample is $1.4 million a year. That figure increases to $5.1 million for those in the largest size group.
Other findings of the report include that at a company-wide level, the average increase in base salaries from 2008 to 2009 was around 2%. Overall, 56% of private equity firms increased base salaries over the period, while 38% made no changes and 6% reduced base pay.
Moreover, 22% of firms are considering a salary freeze, either in the near or longer-term future, while 38% have already implemented one and 40% have either not done so or have not considered it at all.
An equal proportion of firms (43%) reported an increase in bonus payouts compared to those that reported a decrease. 14% of firms reported no change on bonus payouts. The average fall in bonuses was higher (40%) than the average rise (21%).
The large proportion of private equity firms implementing base salary freezes or cutting base salaries is reflective of the performance of private equity funds over the last year, comments the survey.
One-year-horizon returns for buyout and venture funds as of March 31 were -33.8% and -17.1% respectively. With returns likely to move back into positive territory next year, there are likely to be fewer firms implementing salary freezes or cuts, adds the survey.