FORTUNE — Private equity fund documents typically are kept confidential, but you still can learn a lot about firm economics from reading through information that firms must make publicly available via the SEC registration process. The key document is Part 2 of the Form ADV, which serves as a sort of disclosure essay for potential clients.
It’s within these documents that we often learn things like how many firms don’t actually employ some of the professionals listed in the “team” sections of their websites, even if they are listed there as “partners.” For example, some of these folks may actually be “operating partners” who actually get reimbursed by portfolio companies — effectively serving much more like on-call consultants than like in-house staff. We also learn all sorts of other mechanics, such as what types of extra expenses limited partners are, and aren’t, responsible for paying.
So I’ve been going through some of the Form ADVs this morning, and just came across arguably the most ridiculous example of LP fee responsibility.
The firm in question is Clayton Dubilier & Rice, a 36 year-old buyout firm that currently has more than $21 billion in assets under management. Notable investments have included Hertz, HD Supply and ServiceMaster.
According to its Form ADV, CD&R typically charges limited partners a 1.5% annual management fee on capital commitments to its primary funds (co-investment vehicles have different terms), which then drops down to 0.75% on remaining portfolio assets once the fund’s investment cycle has concluded.
Management fees typically are used by private equity firms to pay organizational and administrative expenses, such as salaries and office leases. And usually they must be paid back out of investment profits before the fund managers begin to collect carried interest (i.e., the firm’s cut of the loot).
CD&R’s explicitly identifies several areas in which the management fee is reduced pro rata, including undefined “organizational expenses… to the extend they
exceed a specified amount set forth in the relevant Fund documents” [sic]. But it also appears that LPs are on the hook for a variety of ongoing “administrative” expenses that any layperson would think of as ordinary overhead that should be covered by the management fee. For example:
- Telephone charges
- Internet website hosting and maintenance
- CRM software
- Public relations expenses
That’s right, CD&R generates around $94 million in annual management fees just from its most recent buyout fund, but apparently that isn’t enough to pay for web hosting or phone calls. Or even for press releases that, arguably, the firm is using to market itself. Imagine getting a bill from your financial advisor that included a small surcharge so that he could put up a billboard soliciting other clients? Pretty much the same thing.
Now it’s entirely possible that these “administrative” fees ultimately are reimbursed once the funds begin generating profits, but we would need to see the specific fund documents to know for sure. The Form ADV, however, suggests that they are not.
A CD&R spokesman acknowledged the fee carve-outs, but stressed that they are agreed-to by limited partners. “These are negotiated agreements between the firm and its investors,” he said.
No doubt, but why negotiate at all over such small potatoes, rather than absorb such expenses within the management fee. It does little to either boost the firm’s bottom line or do reduce the overall private equity industry’s ‘fee hog’ image.
Sign up for Dan Primack’s daily email newsletter on deals and deal-makers: GetTermSheet.com
