A management company stress test for operational due diligence: fee income fund by fund, the investment-period cliff, and what a late successor fund does to the cash.
Project the management company's fee income fund by fund, net of the step-downs, against its cost base, and run the cash forward with no successor fund. On the illustrative manager below, fees fall by 30.1 per cent in the year the current fund's investment period ends, the management company's cash runs out in 2029, and only a cost cut of 38.3 per cent would balance that year.
Worked in full in Operational Due Diligence in Private Equity by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Operational due diligence is usually framed around the fund: custody, valuation, cash controls. But the fund is run by a business, and that business lives on management fees that fall on a schedule written into the limited partnership agreement. If the next fund is late or smaller, the team that is supposed to manage the investor's money for another six years starts to leave. The test below takes an hour with the management company's accounts and the fee terms, and it belongs in every review of a manager raising its next fund.
| Input | Value |
|---|---|
| Fund III commitments, fee 2% until the investment period ends in 2028 | 600.0 |
| Fund III net invested capital in 2029, fee 1.5% thereafter | 540.0 |
| Fund III net invested capital realised each year after 2028 | 15.0% |
| Fund II net invested capital in 2026, fee 1.5% | 300.0 |
| Fund II net invested capital realised each year | 20.0% |
| Management company costs in 2026 | 15.0 |
| Cost growth a year | 4.0% |
| Management company cash at the start of 2026 | 6.0 |
Carried interest is left out. It is uncertain, it arrives late, and in most firms it belongs to individuals rather than to the management company. A firm that needs carry to pay salaries is already a finding.
Investment period: fee = commitments × 2%
After the investment period: fee = net invested capital × 1.5%, with net invested capital falling as deals are realised
Casht = casht−1 + feest − costst
In Excel, for Fund III in column C with years in row 2:
=IF(C2<=2028,600*2%,C5*1.5%), with =B5*(1-15%) rolling the invested capital.
In 2026 Fund III pays 600.0 × 2 per cent = $12.0m and Fund II pays 300.0 × 1.5 per cent = $4.5m. Revenue of $16.5m covers costs of $15.0m only 1.1 times. Fund II's fee then shrinks every year as its portfolio is sold, and in 2029 Fund III's fee base switches from $600.0m of commitments to $540.0m of invested capital at a lower rate.
| Year | Fund III fee | Fund II fee | Revenue | Costs | Profit | Cash |
|---|---|---|---|---|---|---|
| 2026 | 12.0 | 4.5 | 16.5 | 15.0 | 1.5 | 7.5 |
| 2027 | 12.0 | 3.6 | 15.6 | 15.6 | 0.0 | 7.5 |
| 2028 | 12.0 | 2.9 | 14.9 | 16.2 | −1.3 | 6.2 |
| 2029 | 8.1 | 2.3 | 10.4 | 16.9 | −6.5 | −0.3 |
| 2030 | 6.9 | 1.8 | 8.7 | 17.5 | −8.8 | −9.1 |
| 2031 | 5.9 | 1.5 | 7.3 | 18.2 | −10.9 | −20.1 |
The firm is roughly break-even until 2028, which is what its current accounts will show. The cliff is in 2029: revenue drops by $4.5m, 30.1 per cent, in a single year: $3.9m of it because Fund III's investment period ends, the rest from Fund II's run-off. Cash turns negative that year. To balance 2029 without a new fund, costs would have to fall by 38.3 per cent, which in a fund manager means people, and the people cut first are rarely the ones the investor would choose.
The timing matters for an investor in Fund III. The years after 2028 are when its portfolio is being grown and sold, the part of the fund's life where team continuity is worth the most. The fee schedule removes the money at precisely that point.
| Scenario | First year of negative cash | Cash at end 2031 |
|---|---|---|
| No Fund IV | 2029 | −20.1 |
| No Fund IV, costs cut 25% from 2029 | 2030 | −6.9 |
| $700.0m Fund IV, fees from 2031 | 2029 | −6.1 |
| $700.0m Fund IV, fees from 2029 | none | 21.9 |
A Fund IV of $700.0m at 2 per cent adds $14.0m a year and restores a healthy margin, with cash of $21.9m by the end of 2031. Two years late, the firm spends 2029 and 2030 below zero and is still in deficit at the end of 2031, even with Fund IV's fee flowing. A 25 per cent cost cut buys one year, not a solution. The manager's survival is, in effect, a bet on the timing of the next close; whether a first close covers the management company works the same question from the other side.
Reading this year's profit as stability. The 2026 accounts show a $1.5m profit and $7.5m of cash. Nothing in them shows the 2029 cliff; it is in the fund documents, not the financial statements. Stability is a projection, and the reviewer has to build it.
Run the management company forward by fund, through the step-downs, with no successor fund. Record the first year of negative cash and the cost cut needed to balance the step-down year, here 2029 and 38.3 per cent, and weigh them in the governance and business-risk domains of the review. How such a finding should enter the rating, without being averaged away, is the subject of the free workbook for this case; for how a fee step-down is calculated, see how the management fee is calculated after the investment period.
Because the team that manages the fund is paid from management fees that fall on a schedule. In the worked case fees drop 30.1 per cent in the year the investment period ends and the management company's cash turns negative in 2029, just as the portfolio needs the team most. A stable fund needs a solvent manager.
The fee usually moves from commitments to net invested capital, often at a lower rate, and then falls as deals are sold. In the worked case Fund III pays $12.0m a year on $600.0m of commitments until 2028, then $8.1m on $540.0m of invested capital at 1.5 per cent, shrinking each year after.
Only if it closes on time. A $700.0m successor at 2 per cent adds $14.0m a year: from 2029 the manager ends 2031 with $21.9m of cash, but two years late it is still at minus $6.1m. The timing of the next close is the variable a reviewer should stress, not just its size.
This article is one calculation from Operational Due Diligence in Private Equity. 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.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: private equity and private markets → · All 453 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.