The fee waiver against a cash GP commitment, on the same pre-tax money, with the fund multiple at which it stops paying.
In a management fee waiver, the GP gives up part of its fee and is credited with the waived amount as its commitment, earning it back only through a priority share of fund profits. On an illustrative 300 million real estate fund with a 6.0 million GP commitment, waiving 1.2 million of fee a year for five years leaves the partners 1.20 million better off after tax at a 1.6x fund multiple, but 3.60 million worse off if the fund only returns its capital.
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 →
LPs expect the manager to put its own money in, commonly 1 to 2 per cent of commitments. For a first or second fund that cheque is often larger than the partners' liquid savings. A fee waiver lets them fund it with fee income they have not yet been paid. Where the structure works as intended, the partners also change the tax character of that money: instead of receiving a fee taxed as income and investing what is left, they forgo the fee and receive a share of the fund's gains. The price is risk. A fee is paid whatever happens; a profit allocation is paid only if there are profits.
| Input | Value |
|---|---|
| Fund commitments | 300 |
| Management fee, on commitments | 1.5% = 4.50 a year |
| GP commitment, 2.0% of the fund | 6.0 |
| Fee waived each year, over five years | 1.2 (26.7% of the fee) |
| Tax rate on fee income | 40% |
| Tax rate on fund gains | 20% |
| Fund net multiple, base case | 1.6x |
Cash route: pre-tax fee needed = commitment ÷ (1 − income tax) = 6.0 ÷ 0.60 = 10.0
Cash route outcome = 6.0 × M − capital gains tax on 6.0 × (M − 1)
Waiver route outcome = profit allocation × (1 − gains tax) + the 4.0 of fee not waived, after income tax
Profit allocation = MIN(6.0 × M, fund profit). In Excel: =MIN(B3*B8,MAX(0,(B8-1)*B1))
Compare the two routes on the same pre-tax money: 10.0 of fee income.
Cash route. The partners receive 10.0 of fee, pay 4.0 of income tax and invest the remaining 6.0. At 1.6x the stake returns 9.60. Tax at 20 per cent on the 3.60 gain is 0.72, leaving 8.88.
Waiver route. The partners waive 6.0 of fee, which is credited as their commitment, and take the other 4.0 as fee, 2.40 after tax. At 1.6x the priority allocation is 9.60, the waived 6.0 grown at the fund multiple. Fund profit is 180.0, so it is fully covered. Taxed as gains it leaves 7.68; with the 2.40 of fee the total is 10.08.
Difference. 10.08 − 8.88 = 1.20, or 12.0 per cent of the 10.0 of pre-tax fee. It is exactly the income tax that the waived 6.0 never bore, 2.40, less the extra gains tax on that 6.0, 1.20: the advantage is a rate difference applied to the amount waived, not a return.
| Fund multiple | Fund profit | Cash route | Profit allocation | Waiver route | Waiver advantage |
|---|---|---|---|---|---|
| 0.50x | 0.0 | 3.00 | 0.00 | 2.40 | -0.60 |
| 0.90x | 0.0 | 5.40 | 0.00 | 2.40 | -3.00 |
| 1.00x | 0.0 | 6.00 | 0.00 | 2.40 | -3.60 |
| 1.02x | 6.0 | 6.10 | 6.00 | 7.20 | 1.10 |
| 1.30x | 90.0 | 7.44 | 7.80 | 8.64 | 1.20 |
| 1.60x | 180.0 | 8.88 | 9.60 | 10.08 | 1.20 |
| 2.00x | 300.0 | 10.80 | 12.00 | 12.00 | 1.20 |
The shape is a cliff, not a slope. Above a fund multiple of about 1.020x the profit allocation is fully covered and the waiver is worth a flat 1.20 whatever the fund does. Below 1.015x it loses, and at exactly 1.00x it loses 3.60: in cash the partners would have got their 6.0 back, under the waiver they get nothing, because there is no profit to allocate. A value-add real estate fund that returns its capital after a bad cycle is not an exotic outcome, and that is precisely where the waiver bites.
The LP's cash outlay is the same 4.50 a year either way: under the waiver part of it is redirected from fee to the GP's credited commitment, and the GP's priority allocation is paid out of profits that would otherwise go to the LPs. What changes most is alignment: under a waiver no partner wrote a cheque, and the commitment is at risk only in the sense that an expected fee may not be replaced. Many LPs ask that at least part of the GP commitment be funded in cash, and that waivers be elected before the fee period they cover. Tax authorities have also scrutinised waivers. In the United States, the IRS issued proposed regulations in 2015 under section 707(a)(2)(A) of the Internal Revenue Code on disguised payments for services, which target waivers whose allocation does not carry significant entrepreneurial risk and could treat them as fee income. The tax rates in this example are illustrative, the outcome depends on the jurisdiction and the drafting, and nothing here is tax advice: the structure needs specialist advice.
A fee waiver is worth a fixed tax arbitrage, 1.20 here, as long as the fund makes a profit at least as large as the grown waiver, and it costs the whole commitment if the fund only returns capital. Present it to LPs alongside a cash element. Terms, GP commitment and the economics of the management company are what the book works through, and the free workbooks for the book include a blank model for your own raise. See also how much a GP should commit and how a GP commitment loan changes the partners' return.
To fund the GP commitment without cash and, where the tax treatment is respected, to receive a profit allocation taxed as gains instead of fee taxed as income. In the US, 2015 IRS proposed regulations under section 707(a)(2)(A) target waivers without real risk; take specialist advice. On the illustrative fund, at illustrative 40 and 20 per cent rates, the advantage is 1.20 million on a 6.0 million commitment whenever fund profit covers the allocation.
The GP gets nothing back for the waived amount, because the priority allocation is paid only out of fund profits. A cash commitment would have returned what the fund returned. At a 1.00x fund multiple the cash route leaves 6.00 million, the waiver route 2.40 million: a loss of 3.60 million.
Often in part. The LP's cash outlay is the same 4.50 million a year either way, part of it redirected from fee to the GP's credited commitment, but the partners write no cheque, so many LPs ask for a cash element and for waivers to be elected before the fees accrue. Expect questions on how much of the commitment is cash.
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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