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New Wharton Study Shows the Measure of the Buyout Fee Racket

The most detailed study to date of management fees shows the funds raked in close to 20% in fees of the funds under management - with carried interest accounting for only around a quarter of the total.

As we wrote in A Workers' Guide to Private Equity Buyouts, one of the key methods used by private equity funds to pump cash out of the companies they acquire is their ability to collect gargantuan fees, including "additional fees for each financial service, which typically consist of loading more debt on to the acquired company's books. Acquisition fees, management fees and "financial advisory" fees can total as much as 5% of the amount of the fund under management. Given that the funds under management run into billions of dollars, these fees easily add up to hundreds of millions. So the fees alone can make a buyout deal extremely profitable for a private equity firm even if the company purchased is no longer profitable!"

Just how profitable this can be has now been meticulously demonstrated in a new study from the prestigious US Wharton School, where two researchers have examined the data available to a large institutional investor in the funds. The results of the study, incorporating records from investments in no less than 144 individual funds over the period 1992-2006, showed fees on "carried interest" - the percentage of the profit resulting from the sale of the company and/or dividends - yielded on average 5.41% of the funds under management, but accounted for only around a quarter of the total fees raked in. Management fees associated with the acquisition (levied on the acquired company), exit and other creative advisory/operational fees brought the average fee revenue to a whopping USD 19.76 for every 100 dollars under management!

As the Wall Street Journal commented, "The pace of private-equity deal making slowed almost to a halt in August… With their funds sitting stagnant, private-equity firms could reduce the size of their existing and future funds, much as venture-capital firms did early this decade. The lure of billions of dollars in management fees suggests that won't be the case. Buyout firms are more likely to continue to deploy high levels of capital and pursue deals that don't rely so heavily on the sale of debt for financing, typically for 70% of the purchase price. Of course, that would only bring down carried-interest returns, making management fees an even bigger percentage of total income for the funds."