PE, VC funds slash their fees, aim for higher carry

livemint.com:

MUMBAI : Private equity (PE) and venture capital (VC) funds are slashing the management fees they charge investors to enhance returns, cut investing costs, and attract funds, according to portfolio managers and limited partners. The emergence of multi-fund platforms led several PE and VC firms to move away from the traditional ‘2-20 model’, or 2% management fee and 20% carry, where the fund retains a part of the investment profit upon realization. To be sure, this new trend is seen in firms raising multiple funds with large corpus and smaller ones that are into their subsequent fund cycles.

Small franchises with a single-fund structure still charge a 2% fee to meet management costs. In some cases, the funds are either charging zero fees or have reduced it significantly to 1%. Some firms that have done this include Sixth Sense Ventures, 3one4 Capital, Kae Capital (in their opportunities fund), Artha Venture Funds, Elev8 Venture Partners, and TVS Capital.

“The issue is with the 2% management fee. LPs (limited partners) are bargaining for a lower fee to ensure better IRR (internal rate of return) outcomes," said Gopal Srinivasan, the chairman and managing director of TVS Capital. IRR is the internal rate for a PE or VC fund, or the annualized return a fund will generate based on a series of cash flows over the fund’s tenure, typically 10 years.

For example, when a general partner (GP) raises ₹100 from an investor, there is a 2% upfront fee that the firm charges each year. By the time the fund, with a lifespan of 10 years, is into its fourth year, already ₹10 is earned as fees, bringing down the investible corpus to ₹90. “The LPs are pushing back on this.