The cap measured on final commitments, the excess offset against the management fee, and the true-up between the first and the final close.
An organisational expenses cap limits the formation costs a fund may bear, usually to the lesser of a percentage of commitments and a fixed amount; the manager bears the excess, most often as a 100 per cent reduction of the management fee. With a cap of the lesser of 0.15 per cent and 1,500,000, a fund that closes on 900 million bears 1,350,000 of its 2,120,000 of formation costs, and the manager's first-year fee is cut by 770,000, 4.9 per cent. The COO's real work is the true-up: at the first close the same cap allowed only 600,000.
Worked in full in The Private Markets COO by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Limited partnership agreements typically let the fund pay its own organisational (in US documents, organizational) expenses up to a cap, and require the manager to bear anything above it, either by paying it directly or by reducing the management fee. The percentage limb scales with the fund; the fixed limb stops a very large fund from carrying an unlimited bill. Placement agent fees are normally excluded from organisational expenses and handled by their own offset. How large the formation budget is, and how the fund size at final close decides who pays it, is worked in how much it costs to set up a real estate fund; this article takes the cap as given and follows it through the administration: the fee offset, the true-up at each close and each investor's share.
Cap = MIN(cap percentage × commitments at final close, fixed cap)
Excess borne by the manager = MAX(organisational expenses incurred − cap, 0)
Net management fee = gross fee − excess × offset percentage
Excel: =MAX(Incurred-MIN(CapPct*Commitments,CapAbs),0)
A fictional buyout fund raising over three closes, with a cap of the lesser of 0.15 per cent of commitments and 1,500,000, an excess offset 100 per cent against the management fee, and a fee of 1.75 per cent on commitments. The fixed limb would only bind above 1,000 million of commitments.
| Item | Amount | Share |
|---|---|---|
| External legal counsel, fund documents | 1,620,000 | 76.4% |
| Tax and structuring advice | 310,000 | 14.6% |
| Regulatory registrations and filings | 70,000 | 3.3% |
| Travel, printing, data room | 120,000 | 5.7% |
| Total | 2,120,000 | 100% |
Step 1, the cap at final close. 0.15% × 900,000,000 = 1,350,000, below the 1,500,000 fixed limb, so the cap is 1,350,000.
Step 2, the excess. 2,120,000 − 1,350,000 = 770,000, borne by the manager.
Step 3, the fee offset. The first full year's fee is 1.75% × 900,000,000 = 15,750,000; after the offset, 14,980,000, a 4.9 per cent reduction. The fund bears 63.7 per cent of the formation costs and the manager 36.3 per cent.
Step 4, the investor's share. The 1,350,000 borne by the fund is shared by commitment, 0.15 per cent of each: an investor committing 50,000,000, 5.56 per cent of the fund, bears 75,000. Investors admitted at later closes pay their share through the equalisation payment, as in how equalisation interest is calculated.
Most of the costs are incurred before the first close, when the cap, measured on commitments to date, is at its smallest. The administrator applies it provisionally and recomputes at every close.
| Close | Commitments | Cap | Incurred to date | Excess offset | Change in offset |
|---|---|---|---|---|---|
| First close | 400,000,000 | 600,000 | 1,800,000 | 1,200,000 | 1,200,000 |
| Second close | 650,000,000 | 975,000 | 2,010,000 | 1,035,000 | -165,000 |
| Final close | 900,000,000 | 1,350,000 | 2,120,000 | 770,000 | -265,000 |
At first close the manager absorbs 1,200,000 through the fee. By the final close the cap has more than doubled and the excess has fallen to 770,000, so 430,000 of fee offset taken earlier is reversed in the manager's favour, through the next fee calculation. That reversal needs a clear record, because it appears to investors as a fee that went up after the final close.
Freezing the first-close cap makes the manager bear 1,520,000 instead of 770,000, 750,000 too much. The opposite error, applying the hoped-for final-close cap from day one, charges first-close investors costs the cap may never permit if the fund closes small. Provisional, then trued up, is the only version that is right at every close.
| Final commitments | Cap | Costs 1,500,000 | Costs 2,120,000 | Costs 2,800,000 |
|---|---|---|---|---|
| 600 million | 900,000 | 600,000 | 1,220,000 | 1,900,000 |
| 900 million | 1,350,000 | 150,000 | 770,000 | 1,450,000 |
| 1,200 million | 1,500,000 | 0 | 620,000 | 1,300,000 |
Above 1,000 million the fixed limb binds and the cap stops growing, so a larger fund saves the manager less than the percentage suggests. A fund that closes at 600 million with the same legal bill leaves the manager with 1,220,000, which is why formation budgets should be set against a conservative fund size.
The economics certificate and the fee calculation with its controls are among the downloads with the free workbook for this book; for offsets of other fee income, see how to recompute a management fee after offsets.
The costs of forming the fund and offering interests: fund counsel for the limited partnership agreement and subscription documents, tax and structuring advice, regulatory registrations and filings, and the related travel, printing and data room. Placement agent fees are normally excluded and treated separately. In the worked case they total 2,120,000, of which legal counsel is 76.4 per cent.
Usually on commitments at the final close, because the percentage limb grows with the fund. Administrators apply it provisionally at each close and true it up. In the illustration the cap is 600,000 at a 400 million first close and 1,350,000 at the 900 million final close; freezing the first-close cap would make the manager bear 1,520,000 instead of 770,000.
The capped amount, shared by commitment, so every investor bears the same percentage of its commitment, late closers included through their equalisation payment. With 1,350,000 borne on 900 million, that is 0.15 per cent: an investor committing 50,000,000 bears 75,000.
This article is one calculation from The Private Markets COO. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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