A formation budget line by line, the organisational expense cap, and why the size the fund closes at decides who pays.
On an illustrative 300,000,000 first-time real estate fund, setting up costs about 1,350,000: 1,085,000 of legal, tax, regulatory and administration work that the fund can bear as organisational expenses, and 265,000 of travel and marketing that the manager pays itself. Add a 2 per cent placement fee on 80,000,000 of introduced capital and the raise costs 2,950,000, 0.98 per cent of target. How much of that the manager ends up carrying depends less on the budget than on the size at which the fund closes, because the expense cap in the LPA is a percentage of commitments.
Worked in full in Raising a Real Estate Fund by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Founders usually budget formation costs once, at target size, and assume the fund will reimburse them. The fund will, up to a cap. Below the size the budget was built for, the excess falls on the manager at exactly the moment its fee income is also smaller.
| Item | Who pays | Cost |
|---|---|---|
| Fund counsel: LPA, subscription documents, PPM | Fund, within cap | 650,000 |
| Tax and structuring advice | Fund, within cap | 150,000 |
| Side letters and investor negotiation | Fund, within cap | 120,000 |
| Regulatory filings and fund vehicle set-up | Fund, within cap | 90,000 |
| Administrator onboarding | Fund, within cap | 40,000 |
| Audit and tax set-up | Fund, within cap | 35,000 |
| Organisational expenses | 1,085,000 | |
| Travel and roadshow | Manager | 220,000 |
| Pitch book, data room and printing | Manager | 45,000 |
| Total formation cost | 1,350,000 |
The LPA caps organisational expenses borne by the fund at 0.40% of final commitments; anything above is paid by the manager. The management fee is 1.5% of commitments, 375,000 a month at 300,000,000. A placement agent introduces 80,000,000 at 2%, and the fee is offset in full against the management fee, so the manager bears it.
Cap = final commitments × cap percentage
Borne by the fund = MIN(organisational expenses, cap)
Borne by the manager = organisational expenses − borne by the fund + marketing + placement fee
In Excel, with commitments in B2 and the cap rate in B3, =MIN(Org,B2*B3) for the fund's share and =Org-MIN(Org,B2*B3)+Marketing+Placement for the manager's. Express the manager's share in months of fee, =GP_cost/(B2*Fee/12), to see what it does to the management company.
At 300,000,000 the cap is 1,200,000, above the 1,085,000 of organisational expenses, so the fund bears them all: 0.36 per cent of commitments, or 36,167 for every 10,000,000 an investor commits. The manager bears 265,000 of marketing and the 1,600,000 placement fee, 1,865,000 in all, which is 5.0 months of the management fee.
| Final size | Cap at 0.40% | Fund bears | Excess to manager | Manager total | Months of fee |
|---|---|---|---|---|---|
| 150,000,000 | 600,000 | 600,000 | 485,000 | 2,350,000 | 12.5 |
| 200,000,000 | 800,000 | 800,000 | 285,000 | 2,150,000 | 8.6 |
| 250,000,000 | 1,000,000 | 1,000,000 | 85,000 | 1,950,000 | 6.2 |
| 300,000,000 | 1,200,000 | 1,085,000 | 0 | 1,865,000 | 5.0 |
The cap covers the budget only from 271,250,000 of commitments. A fund that closes at half its target leaves the manager with 485,000 of legal and set-up costs on top of its own marketing and the placement fee, and the whole burden is 12.5 months of a fee that is itself half the size planned. The legal bill does not halve when the fund does: the LPA, the PPM and the side letters cost much the same for 150,000,000 as for 300,000,000.
Most LPAs measure the cap on commitments at the final close, but the fund starts reimbursing the manager from capital called well before that. Measured at a 100,000,000 first close the cap would be 400,000, leaving 685,000 of the budget unreimbursed. Make sure the LPA lets that balance carry forward and be reimbursed as later closes lift the cap; otherwise the manager finances it for the length of the fundraise, and keeps it for good if the fund never grows.
| Cap | 150,000,000 | 200,000,000 | 300,000,000 |
|---|---|---|---|
| 0.25% | 710,000 | 585,000 | 335,000 |
| 0.40% | 485,000 | 285,000 | 0 |
| 0.50% | 335,000 | 85,000 | 0 |
Investors negotiate the cap down, and a first-time manager with no leverage often concedes it. Each step down is paid by the manager unless the fund reaches the size the budget assumed. Some LPAs use a fixed amount rather than a percentage; that protects the manager if the fund closes small and protects investors if it closes large. The common investor ask, the lower of a percentage and a fixed sum, gives the protection to investors in both cases, so a manager who expects to close below target should argue for the fixed sum alone.
The mistake is to build the formation budget at target size and treat the fund's reimbursement as certain. The second is to count placement fees and travel as organisational expenses: investors expect the manager to pay the cost of selling them the fund, and a placement fee charged to the fund is normally offset against the management fee, so the manager pays it either way. Whether the agent is worth it is a separate calculation, in is a 2 per cent placement agent fee worth paying. And the 1,865,000 the manager carries lands on a management company that is already short at first close, as does a first close cover the management company's costs shows.
Budget 1,350,000 to set up this 300,000,000 fund, and about 2,950,000 with the placement agent. The fund bears the 1,085,000 of organisational expenses only if it closes above 271,250,000; at 150,000,000 the manager carries 2,350,000, 12.5 months of its fee. Run the budget at the size you expect to close, not the size you are marketing. Raising a Real Estate Fund sets out the management company budget, break-even and the fee across the fund's life; the free workbook for this case runs the raise on a calendar against the burn.
The fund, up to the cap in the LPA, and the manager above it. With a 0.40 per cent cap and 1,085,000 of legal, tax, regulatory and set-up costs, a 300,000,000 fund bears them all, but a 200,000,000 fund bears only 800,000 and the manager pays the other 285,000.
Investors generally expect the manager to bear them. Where the fund pays the agent, the fee is normally offset in full against the management fee, so the cost reaches the manager either way. A 2 per cent fee on 80,000,000 of introduced capital is 1,600,000, more than the whole organisational budget here.
Caps are set either as a percentage of commitments or as a fixed amount, often the lower of the two. The test is what the cap covers at the size you will actually close: a 0.40 per cent cap covers this 1,085,000 budget only from 271,250,000; at 0.25 per cent the manager absorbs 335,000 even at 300,000,000.
This article is one calculation from Raising a Real Estate Fund. 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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