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Blackstone kills off controversial private equity fees

October 8, 2014, 8:59 PM UTC
The logo for Blackstone Group LP is displayed during the opening of the company's new office in Singapore, on Monday, Oct. 21, 2013. Blackstone, the world's biggest manager of alternative assets such as private equity and real estate, last week reported that third- quarter profit rose 3 percent as gains in property holdings offset a decline in its buyout unit. Photographer: Munshi Ahmed/Bloomberg *** Local Caption *** Stephen Schwarzman
Photograph by Munshi Ahmed — Bloomberg

The Blackstone Group will no longer charge portfolio companies for services not rendered, as first reported this morning in The Wall Street Journal.

Yes, you read that correctly. For years, Blackstone (BX) and many other private equity firms have charged something called “accelerated monitoring fees.” What it basically means is that, after buying a company, Blackstone would set an annual fee that the company would pay for various (often undefined and unverified) services. For example, $5 million per year for 10 years. The kicker is that if Blackstone exits the company prior to the 10 years being up — either via a sale or IPO — it gets the extra years in a lump sum payment.

Going forward, Blackstone no longer will write acceleration clauses into its monitoring fee agreements. For existing portfolio companies, it either will distribute 100% of the accelerated fee to limited partners or will cut other fees a commensurate amount.

To be sure, this is a positive development. The idea of guaranteeing 10 years of fees is absurd in a private equity market where average hold times are significantly shorter.

That said, I’d prefer that Blackstone kill off generic monitoring fees altogether. Private equity firms already are paid handsomely by investors on an annual basis via a top-line management fee, which seemingly should cover portfolio management. I certainly understand that there may be certain portfolio projects that require additional resources, but there is no way to know that from the outset — nor does a smooth annual fee correspond to such lumpy needs. Moreover, maintaining monitoring fees while killing the acceleration clause could even serve as a perverse incentive for Blackstone to hold onto a portfolio company for one or two extra years so as to milk the fees. It’s unlikely given the dollars involved, but why dangle the carrot?

For Blackstone, we’ll know a lot more once details leak on its broader fee-sharing arrangement for the new flagship fund it just began raising. The firm currently shares 80% of all monitoring fees with its limited partners, a much higher figure than what you would have found in past Blackstone funds (per a broader industry trend). If it goes with a full 100% share like some rival firms (e.g., Warburg Pincus) then monitoring fees likely will disappear on their own, since the GP would have greater incentive to let the portfolio company keep the cash on hand. But if it sticks at 80%, it would be great to see it realize that monitoring fees are nearly as noxious as accelerated monitoring fees.

A Blackstone spokesman declined to comment.

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