In response, a pension fund manager named Andrew emailed to wonder if the Huntsman Gay situation is reflective of a larger structural problem in private equity:

“There was something in the article about Huntsman Gay that compelled me to write to you – your mention that the fund is running out of dry powder, base fees have dropped post the investment period and the GP is cutting back on staff. Following a conversation along similar lines with a local GP last year, I started thinking about the standard management fee structures and how the structure is inefficient. When the local GP first mentioned they may have to cut staff after the investment period of the current fund if they could not raise another fund, I thought ‘that’s not my problem – it’s up to you to manage your business properly to ensure it is sustainable.’ Then I thought again and realized it is my problem, as an LP in the existing fund, as less staff may have an impact on the GP’s ability to manage effectively the companies in the existing portfolio.

This made me think about how inefficient the standard management fee structure can be, where income is high during the investment period then drops off a cliff post-investment period – GPs then look to replace this lost revenue with revenue from a new fund. Surely there must be a more efficient fee structure to avoid this problem – for example, a more even spread of management fee income over the life of the fund, where an estimate of total management fees payable over the life of a fund is made and this is allocated in a more ‘sculpted’ structure over the whole life of the fund.  This recognises that there is a lot of work still required of a GP in managing existing investments after the investment period, it reduces the incentive to raise a new fund to replace the management fee income lost post-investment period and it benefits both the GP and LPs as the GP is better able to spread income and build a sustainable business that is resourced appropriately.”

I published Andrew’s note in this morning’s Term Sheet email, which elicited the following reply from Kelly:

“The reason you need to downsize [in this situation] is that there is simply less work. Most GPs who have any active checkbook spend a considerable amount of time vetting potential new investments, including generating new deals for pipeline, performing preliminary due diligence to funnel down opportunities, performing intense due diligence on investments that pass the hurdle, arranging financing on syndicates for deals in hot pursuit, negotiating final deal terms, etc. All of this activity dwindles rapidly as the checkbook runs dry, especially when there is no fundraising on the immediate horizon to re-stoke the engine.

In GPs that run in silos, the sourcing and financing staff begin to bail first, and across the board junior and midlevel staff begin to bail. But, of course, the portfolio also begins to shrink as well. Key senior guys to tend to stay to manage out the string – because if they don’t LPs will remember and ‘they will never work in this down again’ if they don’t. There is in fact an opposite problem – if portfolio performance has really been poor the GP may realize that he may ‘never work in this town again,’ leading him to keep zombie companies going while he seeks fee extensions after the ‘normal’ fund life has ended in order to keep his skeleton staff fed, including of course himself.