The recomputation runs base first, rate second, offsets last. A fund with commitments of 400,000 paying 1.50 per cent per annum, quarterly in advance, on the acquisition cost of unrealised investments has year-seven bases of 310,000, 310,000, 265,000 and 265,000, a gross fee of 4,312.50, and offsets of 2,175 — a net management fee of 2,137.50. The offset removes half the charge, and many statements of operations present only the net.
The base decides the fee, not the rate
During the investment period the management fee is charged on committed capital. Every investor pays on the full commitment from the first closing, drawn or not, on the logic that the manager is building a team and sourcing deals. After the investment period the base switches to something reflecting what is still invested: the acquisition cost of investments not yet realised, net invested capital, or net asset value.
The choice is not academic. A portfolio that cost 300,000 and is now marked at 450,000 generates a fee on 300,000 under a cost base and on 450,000 under a net asset value base — half as much again, and less than the cost base had the portfolio fallen. The base changes the manager's income by fifty per cent and changes the direction of their exposure to their own performance. A cost measure declines only as things are sold. A net asset value measure moves in both directions.
Year seven, quarter by quarter
Take a fund with total commitments of 400,000. The fee is 2.00 per cent per annum on commitments during the investment period and 1.50 per cent per annum thereafter on the acquisition cost of investments not yet realised, measured quarterly in advance. The investment period ends at the midpoint of year six. The acquisition cost of unrealised investments at the transition date is 310,000. At the end of the second quarter of year seven, an investment with an acquisition cost of 45,000 is realised.
Period
Base
Fee
Quarter one
310,000
1,162.50
Quarter two
310,000
1,162.50
Quarter three
265,000
993.75
Quarter four
265,000
993.75
Gross fee for the year
4,312.50
Because the base is measured in advance, the realisation at the end of the second quarter first affects the third quarter. The transition year is the harder one: 2.00 per cent on 400,000 for the first half is 4,000, and 1.50 per cent on 310,000 for the second half is 2,325, so year six costs 6,325 and the fee falls by 21 per cent in a single year. Had the post-transition base been measured at the year end rather than at the transition date, after the year's realisations, the answer would have been lower again.
The offset, and the sentence at the end of it
Managers receive fees from portfolio companies that would not exist without the fund's capital. In year seven the manager received a transaction fee of 1,800 on an acquisition, monitoring fees of 900 and directors' fees of 200. The agreement offsets 100 per cent of the fund's proportionate share, and the relevant company is held 75 per cent by the fund and 25 per cent by a co-investment vehicle.
Item
Amount
Transaction fee
1,800
Monitoring fees
900
Directors' fees
200
Fees received by the manager
2,900
Offsettable at the fund's share of 75 per cent
2,175
Gross fee
4,312.50
Net management fee
2,137.50
Year seven. Directors' fees are a common carve-out; here they are included.
The statement of operations should show a management fee of 4,313 with an offset of 2,175 beneath it, or a net figure of 2,138 with the components in the note. If it shows 4,313 and no offset line, the credit was not applied, and the question is which of three things happened: the income was received by an affiliate outside the offset definition, it was treated as a carve-out, or it was missed. All three occur. For an investor holding 8,000 of the 400,000, or 2.00 per cent, the same arithmetic reads gross 86.25, offset credit 43.50, net 42.75.
The clause worth reading to the end is the one on excess. Suppose that in year eight the base has fallen to 220,000, giving a gross fee of 3,300, and the manager receives a break-up fee of 5,000 on an aborted transaction, of which the fund's share is 4,000. Offsets exceed the fee by 700. If the excess carries forward, next year's fee is reduced by 700. If it lapses, the manager keeps 700 of income generated by the fund's capital, and the accounts show a management fee of nil with no indication that anything was left on the table.
A cost base does not fall when a holding is written down. A holding acquired for 40,000 and marked at 8,000 keeps generating a fee on 40,000 until it is sold or written off. On an unrealised portfolio costing 265,000 at 1.50 per cent, the fee is 3,975 a year; reduce the base by the 32,000 write-down and it is 3,495 — a difference of 480 a year, or 2,400 over a five-year tail on commitments of 400,000. That is more than half a percentage point of committed capital, moved by a single clause about impairment.
What to do with the difference
Recompute once per fund. Extract the rules — rate, base definition, measurement dates, step-down triggers, offset terms. Extract the inputs — total commitments, and from the schedule of investments the acquisition cost of each unrealised holding and the date of each realisation. Build the base at each measurement date, apply the rate, sum, deduct offsets, compare.
Where the recomputed figure and the reported figure differ, the cause is almost always one of six conventions, and an administrator can point to it in a minute:
the base is measured in advance rather than in arrears;
a mid-period realisation was or was not reflected in that quarter's base;
an investment was committed but not yet funded;
a written-down holding is still carried at full cost in the base;
the offset percentage or the fund's proportionate share differs from the assumption;
the accrual cut-off at the period end moved the expense between years.
In the transition year, the measurement date for the post-step-down base is the single most common source of a difference. Identify the convention, document it, and apply the same one next year. The exercise also establishes the acquisition cost of every unrealised holding, the realisation history, and the manager's other sources of income from the portfolio — which is why it is the highest-yield hour in the review.
The workbooks behind this article
Every figure above is a live formula in the free companion files for
How to Read a Private Fund’s Financial Statements. Each workbook ends with a Checks sheet
setting the printed figure beside the computed one. No account and no email address.
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