Fees vs. Carry

Updated Do private equity firms make more money from management fees than from carried interest related to their investments?

That was the subject of a C1 story in today’s Wall Street Journal, based on a working paper by Wharton finance professors Andrew Metrick and Ayako Asuda. You can download their research here: PE_Economics.pdf

In short, the answer is yes. The researchers found that buyout and VC fund managers generate about 60% of their “revenue” from fees, with the remainder coming from carried interest. Sounds kind of ominous on its face, and makes PE look like a bit of a shell game.

But it’s imperative to keep in mind that these numbers are not net of expenses. In other words, much of that 60% goes to activities under the rubric of “keeping the lights on” — including office leasing, travel, legal expenses, etc.

One of my colleagues put it this way: “Management fees are designed to cover the costs of running a buyout firm, while the carried interest is the profit. Just like any other business, you’d only expect profit to be some modest percentage of total revenue (fees + carry).”

Ok, it’s not quite apples to apples, but the analogy is still apt. No doubt certain firms use management fees as a profit center (as the Blackstone S-1 indicates), but most firms also are required to pay back management fees before receiving carry. Again, it doesn’t always work out that way, but I’m just uncomfortable with the idea that this study somehow indicts PE firms.

It’s interesting, but not damning.