November 28, 2024 • 42 mins
In this episode, hosts Ed Barton, Rory Liebhart, and Emily Sander dive into the world of management fees in private equity. They discuss how PE firms make money, what founders and management teams need to know, and the importance of understanding management fees in deal negotiations.
Key Takeaways:
- Management fees are a crucial aspect of private equity investing, and understanding them is essential for founders and management teams.
- PE firms use various fee structures, including management fees, carried interest, and carried capital.
- Management fees can be a significant source of revenue for PE firms, but they can also be a major source of stress for founders and management teams.
- Understanding management fees is critical for navigating deal negotiations and ensuring a successful exit.
Actionable Tips:
- Founders and management teams should understand the management fee structure used by their PE firm.
- PE firms should be transparent about their management fee structures to ensure a smooth deal negotiation process.
- Understanding management fees is essential for navigating the complexities of private equity investing.
Timestamps:
00:34 Diving into Management Fees
02:56 Impact of COVID on Private Equity Funds
10:22 Current Market Challenges and Strategies
24:05 Navigating PE Firm Funding Challenges
25:48 Understanding Carry and Management Fees
29:36 Strategic Advice for PE Firms
34:35 Impact of Debt and Interest Rates
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
(00:07):
Welcome to the Private EquityExperience Podcast.
Your backstage pass to thestrategies, stories, and secrets
that drive value in the PEuniverse.
No filters, no fluff, juststraight talk and expert
insights to help you navigatethe private equity world with
confidence.
And now your hosts, Ed Barton,Rory Liebhardt, and Emily
(00:29):
Sander.
Emily (00:34):
We are back on the private equity experience
podcast and we are going to talkabout management fees.
So we talked a little bit abouthow a PE firm makes money last
episode, but Rory and Ed, whatdo you, what do I need to know?
What do we need to know aboutmanagement fees?
Rory (00:50):
Need to know I'm fresh in from Vegas.
So if I come off as a blearyeyed idiot, uh, you know, I have
an excuse for that.
It's not my normal self.
But it
Ed (00:59):
was a
Rory (00:59):
business trip.
It was a business.
There's all, it was all lots ofprivate equity related
discussions and hobnobbing.
And it was a nice
Emily (01:06):
photo of you in front of that famous fountain or
whatever.
Yeah.
Rory (01:09):
Yeah.
Yeah.
The Bellagio fountains, Bellagiofountains.
Yeah, exactly.
Yeah.
Yeah.
Ed (01:15):
You, you are, uh, You're the, the conference guy.
If I never have to go to LasVegas for a conference again,
I'll be satisfied.
Rory (01:23):
It's just one of those things that it's a necessary, I
won't say evil, but I'm too oldfor this stuff.
I went to Vegas
Emily (01:33):
for three days.
For a conference.
And I don't think I saw adaylight once.
That was how they get,
Ed (01:41):
it's brutal.
It's brutal.
Yeah.
And what you're saying, Rory'sthe truth.
And I'm that much older than youare.
You just can't.
I mean, you come back and you'relike, I need a vacation for my
man.
I remember
Rory (01:51):
when we, we used to do it together.
We used to conquer these thingsand it was a freaking marathon.
Man.
Yeah.
But that's when I used to getbuyer conferences.
Oh, my.
Ed (02:03):
Yeah.
Debt buyers know how to drink.
Um, so yeah, and God blessed.
Did I have to, I was able toback in the day, keep up, but I
can't anymore.
I
Rory (02:16):
remember Ed, one of the things you told me actually,
when I worked for you back inthat timeframe is, you know, if
you actually, I think I wasasking about, Hey, should I get
into business development andsales?
You're like, you need to learnhow to golf and you need to
learn how to drink.
And I'm not very good at eitherof those.
So maybe I'll just stick withfinance and you know, all that
stuff.
(02:36):
So
Ed (02:37):
it's a, it's a safer, it's a safer spot pays better.
Well, maybe not sales paysbetter.
Yeah.
But the two, the two crossover.
Rory (02:44):
I mean, that's, that's the, that's the magic there is
some synergy amongst that.
Yeah.
Anyway, we digress as usual.
So,
Ed (02:52):
yeah, I was, I was actually out while you were partying in
Vegas.
I, I was, I'd got somethingdropped into my lap, which was
You know, we, we talked last,as, as you said, last episode
about the, the fund structureand how private equity gets
paid.
And, you know, there's the,there's essentially the, the 2
percent of the asset managementfee.
(03:13):
And then they get, you know,essentially historically has
been a two and 22 percent of themanagement fee.
2 percent management fee everyyear for what's being managed
for assets under management.
And then the 20 percent of theprofits.
Well, not 24 hours after wefinished putting that, um,
episode in the can, I see a, Isee an article on PE wire that
(03:34):
basically says management feeshave fallen to their lowest
level since tracking began.
And you know, we're seeing,we're seeing That two is now
like one and three quarters anda 20 in some cases is even lower
than 20.
It could be in the fifteens or,or, or tens.
And I was having a, anotherdiscussion with a friend of mine
(03:56):
in private equity this last weekwho said that the funds that
were raised during raised anddeployed during.
Essentially during COVID andpost COVID 20, late 20 through
early 22 are just performinglike dog shit.
And they're having problems kindof showing return to, and to the
(04:17):
LPs are having problems raisingthe next funds.
And of course, We haven't gottento that part in kind of the
series yet, but that's howprivate equity stays alive.
And so I'm curious, you know,what kind of, whether you were
hearing anything in Vegas on, onkind of these issues and, you
know, what, if anything, Itmight portend for private
(04:37):
equity, both for founders andfor, for PE, uh, GPs and LPs,
you know, going forward.
Rory (04:45):
Well, I got a lot of questions along these lines and
had numbers discussions, notonly about, you know, what,
what, uh, you know, what doesthe economics look like for
private equity funds today,venture funds, et cetera, but
also, you know, what, what doesthe capital raising environment
like and how is that?
How's that going?
I think there's a few factors atplay, you know, one you touched
(05:07):
on it is some of these vintagefunds from pre COVID or, you
know, some of that are long inthe tooth from, you know, 21,
you know, this isn't the best M&A environment that the world has
ever seen.
Right?
So, you know, this is about thetime where that vintage is
starting to harvest and sort ofdivest and sort of take shape.
Take profits off the table andbasically start to, you know,
(05:28):
wind these funds down, move onto the next.
Now people are still raisingfunds, but they're extending the
old ones or the, the more, youknow, uh, the vintages past the
typical three to five yeartimeframe to, to longer periods.
So what does that do?
You know, that makes for alittle more fundraising
challenge because typicallyyou're LPs and like, remember
(05:51):
last episode, we talked aboutLPs being those.
Pension funds, endowments,sovereign wealth funds, you
know, insurance companies, etcetera.
And if their money's locked upin one fund, it's sometimes it's
hard to get more money out ofthem.
And I mean, anyone that's beenin the business of raising
capital, whether you're afounder and a venture backed
fund or whatever, or your, yourown operating company, if it's
(06:12):
hard to go back to the samewell, if you've not delivered
them their original investmentback, you know, so, so I think
that's put some strain, youknow, there's still a lot of
capital on the sidelines, but,um, but it's, it's, you know, in
order to, to, to raise funds inan environment like that, you,
you do need to kind of, I guess,quote unquote, get creative on
(06:35):
fee structures.
So yeah, it sounds like feeshave come down.
Some of that also, I think hasto do with scale.
The bigger you get, you know,it's just a lot of large
numbers, you know, charging 2percent on, you know, a 20
billion fund, you know, or, or100 billion fund or whatever.
Um, it starts to look much morelike a mutual fund size where
(06:56):
those fee structures are, youknow, 25 to 50 basis points,
not, you know, 200.
So there's a lot of factors atplay, but yeah, I think, you
know, for a lot of middle marketprivate equity funds, um, you
know, that could be a big.
Is it, because they're Ifthey're having to take a hit on
the fees, you know, hopefullyprofits,
Emily (07:16):
how big of a deal is it?
I mean, obviously 2%, 1.
7, 5%.
I think you said on that amountis a lot, but it was every
single deal right at 2%, or wasthere a little squishiness
around the edges?
Rory (07:30):
But there's always been, yeah, there's
Ed (07:33):
always been some squishiness and and some of the funds.
You know, Emily, if, if it's areal specialty niche, they may
be up in the 2 percent to 5percent range
Emily (07:45):
and, and
Ed (07:46):
for others where it might be a debt fund, um, or leveraged,
leveraged loan fund, they may besub 2 percent or have
historically been sub one downto 1%.
So it has varied, but the, thementality has always been, you
know, two in 22 percent for the,for the Um, kind of base
management fee and 20 percentfor the, or for the carry, the,
(08:09):
the part that's, you know, kindof based on profit.
The interesting thing isprobably, you know, 20 years
ago.
So back when I was gettingstarted, um, that two and 20
turned into two and 20 over.
So you only get your 20 percentover a hurdle rate.
So you kind of got to go, okay,it's two and 20 over 12%.
So, you know, you, once you getthe first 12 percent back to the
(08:32):
limited partners, then you startseeing your, your carried
interest or your carry start,start paying off.
And I think, you know, what,what we're seeing in the market
and I'll give a, I'll give akind of a.
Real life example here in aminute what we're seeing in a
market for my seat is like,look, the, the debt markets suck
because the interest rates arehigh or historically, they're
(08:54):
not historically high, butrelative to the last decade,
they're high.
So it's tougher, you know, kindof finance geek, you're kind of.
Pricing these things on adiscounted cashflow basis and
your discount rate or your riskpremium, or however you want to
describe the, the way you'revaluing the business is driven
by, is driven by a higherrequired return because interest
(09:17):
rates are high.
So that drives prices down.
So the market, you know, sellersare more reluctant to sell
because the valuations have gonedown.
Companies who are bought whenthe, Interest rates were 1%.
Now interest rates are five or 6percent are going, you know,
our, the company's got lessvalue, even if we've grown it,
it may have less value todaythan it did when we bought it.
(09:39):
So it's tough for the PE guys toget out of those companies or
certainly get out of it at aprofit and the.
The leverage piece that theyuse.
So when they do the financialengineering and throw some debt
on for the acquisition, that,that carry is getting more and
more expensive, which reducescashflow.
So, I mean, it's, it's kind ofa, uh, I don't want to say it's
(10:00):
a perfect storm, but it's a,it's a rough market out there
and the, the LPs are going, Hey,we, we want, it's our money.
We want our share.
And yeah, you might not beseeing a lot of that promote
because you're not going to hitthe 12.
Bye.
On the next fund, you know, youowe back to us a little bit.
And so we, we're going to takethat, you know, that why is the
(10:21):
distinction
Emily (10:22):
between the debt market important?
Ed (10:24):
So the debt market, the debt market does two things.
And, and the, the first thingkind of as a practical matter,
the first thing is.
A lot of the private equityfunds will borrow a portion of a
purchase price.
And so, and they, when they buythe company, they go, Hey, we're
going to use some of thecashflow from the operating
business to pay this debt down.
(10:46):
Yeah.
But a service to debt.
Well, most of the time that debtisn't like, you know, if you go
buy a house, you got a fixedrate mortgage, it isn't fixed
rate.
It's variable rate.
And they may or may not havehedged.
You put a, put a hedge on toprotect their interest rate
exposure.
So in some cases or interestpayments may have gone from 80,
(11:07):
000 a month to 270, 000 a monthover the last few years as
interest rates have risen, whichcomes out of the operating
cashflow of that business, whichlimits our ability to reinvest,
to grow, you know, to, to spinoff dividends.
So that's one piece.
The second piece is.
A principle of valuation of anycompany is kind of this concept
(11:28):
of, I've got to get a certainreturn.
And that certain return isagain, going to like finance
theory, a risk free rate, plusthe, plus the risk premium based
upon the riskiness of thatparticular asset.
Well, if the risk free rateThat's kind of driven by the
bond market, the government bondmarket.
So if government bonds have gonefrom a quarter point to two and
(11:51):
a half percent, the requiredreturn goes up by that same
amount by, you know, another twoand a quarter percent.
And so now the discount rateshigher and the business's
valuation goes down, even if thebusiness is doing just as well
or better, the valuation goesdown.
Rory (12:06):
Translation.
Not the greatest thing in theworld to founders, management
teams, looking for somecompensation on a company
valuation.
And not right now, in a waythere's a lot more, uh, cooks in
the kitchen and there's a lotmore hurdles to be cleared
before you see that dough, uh,you know, down the waterfall, as
you say.
So, yeah, I mean, so kind ofgoing back to that comp and, you
(12:29):
know, compensation piece of it,you hit it like, you know, the,
the, the, the firms that have aspecialization.
Can still command the highermanagement fee.
Like, um, you know, I have acouple of, I guess you would
call them, uh, closed end,private equity funds that
acquire assets that are inbankruptcy.
So we do something extremelynichey.
(12:52):
We're able to charge, you know,two and a half percent, but, you
know, we have investors that'llsee headlines like what you
talked about and say.
You know, uh, I I'm seeing nowthat the going rate for AUM fees
is one, one and three quarters.
So like, why are you chargingtwo and a half?
So that, that becomes adiscussion that a fledgling, you
know, fun like ours has tonavigate.
(13:14):
Whereas people see kind of thesemacro trends and like look at it
and compare it to a, you know, aquarter, quarter trillion dollar
fund.
You know, it's, it's a, it's aBritish it's it, this doesn't
bode well for optics aroundsmall.
Funds like this.
So it's you got to specialize.
Um, and that's, that's key inorder to be able to kind of
Emily (13:36):
like the standard is changing.
It sounds like
Rory (13:39):
it's, it is more at a rat more rapid clip perhaps now than
it had been is, you know, it'salways kind of been this.
Baseline two and 20 concept iswe've talked about that seems to
have been the standard for many,many, I mean, decades even.
Um, but yeah, now it's just,it's, you know, there's, there's
different shifts in leverage,right.
And in which side of the dealyou're on.
(14:00):
So, um, right now LPs have thecapital, um, and there's more
choice.
And so, you know, the sponsors,i.
e.
the private equity funds have tomake concessions.
That's just how it goes, youknow?
So,
Emily (14:15):
so how does this compare with like the deals that, um,
We've been a part of, or you twohave been a part of, like, you
mentioned the differentstructure.
I mean, what do you have tostructure differently?
Rory (14:25):
So there's a, there's a few things I think, like in this
particular article that we werelooking at, you know, I think
that the denominator for which,The fees are measured against,
you know, is the commitmentamount, right?
So if, if a LP commits a hundredmillion dollars to a strategy,
(14:47):
in this case, we're talkingabout charging one and three
quarters percent against thatcommitted a hundred million.
What's the difference betweencommitted and called it means if
I've signed on the dotted lineas a commitment, it means that
I'm reserving capital to becalled by the private equity
group at any point in timecalled means, Hey, we're going
to go buy a deal.
(15:08):
You need to fund yourcommitment.
So, so different flavors dictatekind of how the fee structure
works.
I think like.
The charging fees on thecommitment itself is very
private equity fund friendly,not as friendly to the LP.
Whereas other, other strategiessay, we're only going to charge
you a management fee on thecapital we call.
(15:30):
I mean, that's what my funddoes.
We, we don't call, we don'tcharge a management fee on
commitments.
We put it on ourselves to say,if, if, if, if, if, if, if, If
we don't do deals, we're notearning a fee.
So, you know, there's differentflavors of that.
So two and a half percent thatwe charge.
Might sound high, but it'slower, relatively speaking in
(15:51):
the event that, you know, we'recompared against some that are
not actually calling all thecapital deploy and deals.
And so we talk about the M and aenvironment.
The reason you're not, there'sjust not as many deals
happening.
So they're not as much capitalbeing called.
So private equity funds aresaying, Hey, we recognize that
we're not calling and investingas much of your capital.
Maybe in this, this case forthis fund.
(16:13):
We'll seed the rate on what wecharge so that you don't, your
capital doesn't fly from ourfund to some other strategy, you
know?
Emily (16:20):
Holy cow.
Okay.
So like if I'm a founder, I amlike thinking about this at a
couple of different levels, likelike macro economics.
It's like, what is the marketdoing?
Like what are interest ratesdoing?
Um, or is there any like crazyevents happening that would move
the market at that level?
And then it's like, what PE fundam I working with?
Are they Are they large, medium,small?
(16:42):
Are they boutique orspecialized?
Who makes up their LPs?
And what are, what, what'shappening at that level?
And then of course, for what'simportant to me as a founder is
like, how does that affect mydeal structure and how the PEs?
Exactly right.
Rory (16:58):
Yeah.
I think what you're hitting onis really important for a
founder and management, again,working with a founder and these
operating businesses, like Youknow, what is that dynamic
behind my potential investor?
Right?
Like my potential privateequity, what is their dynamic
look like?
You know, you know, look like ifyou're, if you're dealing with
an Apollo, you know, there'snothing to worry about, they're
(17:18):
pretty solid, but if you'redealing with a fledgling, you
know, um, PE group, that's sortof at the table, maybe, you
know, really aggressivelycourting you, but it's hard to
say.
Just how, you know, how, howdeep of a track record they
have, what their LP situationis, that's something to be
cognizant of for sure, becauseyour success is going to be
based on their success.
(17:38):
I was going to
Ed (17:39):
say two other things to keep in mind from a timing
perspective right now is, um,You know, as I had mentioned,
the, the purchases that theymade during COVID, so 2021, 22,
before interest rates started torise, they're underperforming on
balance.
So if you can, so if you canafford to not sell again, a
(18:00):
Pete, the private equity guyshave long term relationships
with their limited partners.
And if they got a couple offunds that aren't doing well,
they're going to be looking toget.
Their next fund to do reallywell.
So they're less likely to bepaying you top dollar.
They're less likely to, to be asaggressive.
They need to get deals done, butthey're going to be looking to
(18:21):
hit long ball on this stuffversus versus small ball on the
other.
Emily (18:27):
Can you outline like a, at a high level?
What a deal looked like preCOVID or during COVID and then
do one for now.
Ed (18:35):
Yeah, I'll, I'll give an example.
We, we were working on a deal.
I was working on a deal with a,with a family office out of the
Bay area about almost two yearsago.
And we were prepared to pay like16 X EBITDA on a, on a
manufacturing and distributionbusiness, which again, made me a
(18:56):
little bit, You know, as a, as ahardcore finance guy, a little
bit, yeah, but we did not getthat deal.
We were outbid by a privateequity firm.
Yeah.
We were outbid by a privateequity firm.
So it was a, it was a familyoffice and it was, and we were
outbid by a private equity firm.
That same deal today wouldn'ttrade at more than 11.
Emily (19:15):
And I'll bet you
Ed (19:16):
it would possibly be single digits and the folks who bought
it are not happy.
We happen to, you know, maintaincontact with a couple of managed
members of the management teamand you know, they're, they're
not happy.
And the issue there is, youknow, in order to get the deals
done, there was a lot of capitalrunning around, interest rates
were low and folks were tryingto get.
(19:38):
Capital deployed.
And so they're like, okay, well,we'll, we'll buy with the
anticipation that growth isgoing to continue.
Well, you know, the economyslowed a bit, interest rates
have risen, their carry cost hasgone up.
And now that business is worthsignificantly less.
And again, if you go from 17, 18X down to nine X.
That business, the same businessperforming the same way, the
(19:59):
value has dropped in half.
So are we still, are we still
Emily (20:03):
talking, are we still talking about the management fee
or, or the fact that PE firmshave different funds that are
open?
Well,
Ed (20:10):
well Pete, so it's a combination of things.
So let me take a step back.
These funds that were opened.
In 2021, 22 are underperformingtoday.
So when the PE guys are goinghat in hand to their limited
partners are going, we needmoney for the next fund.
Yes.
The limited partners are goingto, they're saying two things.
One, those other funds aren'tperforming well.
Emily (20:33):
Yes.
Ed (20:34):
So you need to cut me a deal on this one because I'm not
making as much.
And two, whatever you're doingin this fund had better be
better.
Better than the crap you did inthese last couple of funds.
And so if you were a founderfounding management team, this
is probably not the ideal timeto be selling.
(20:55):
Because the private equity folksneed to be able to kind of
recover their performance, hittheir performance targets.
They need to pay less.
The interest rates are up.
So they're going to be, themultiples have gone down.
And as a, as a management teammember, you may be better off
going, okay, can I, can I pushthrough for another year or two
(21:15):
until interest rates come downbefore I go to market?
Rory (21:21):
Yeah.
So, I mean, that speaks to a fewthings, you know, um, private
equity.
Again, you think about thesethings as I'm buying company, a
company, B company C on a, youthink about it on like a
singular basis.
But at the end of the day, theseare parts of a portfolio.
So these, these, these, thesecumulative deals are looked at
as part of an overall portfolio.
(21:42):
So if you're over performing onone part of your portfolio,
you're trying to make that upon, let's say, investments today
that offset that.
Right.
So ergo, you're paying, you'retrying to buy deals.
At a steeper discount basically.
Um, and so, you know, for, for,you know, touch, you touched on
(22:03):
sort of the environment spell,maybe not ideal, but shoot, it's
still more ideal than trying togo public right now.
You know, that's right up.
So I think the theme that we've,we've talked about in our book
and we touched on even last,last podcast, I think a little
bit was like private equitystill is in many ways.
The most frictionless way torealize value on a business
(22:25):
you've built, you know, so Allof that to say like the private
equity group's always going tobe trying to You know figure out
how to make their own money bothon the LP side and the
investment side Because theymake most of their money, of
course still on theprofitability of these
businesses so, you know, it allworks together, but I just think
that right now is an interestingtime because You know, we have
(22:46):
been in this high interest rateenvironment, you know, political
uncertainty a lot, a lot ofmoney on the sidelines still,
but you know, it's almost likethe skids need to be greased to
get the whole system working asefficiently as we've been used
to over the last top 10 to 15years, really, you know?
Emily (23:04):
Okay.
So if I'm a founder and now Iunderstand, all right, I kind of
have to be aware of what'shappening.
Not like directly impacting me,but like indirectly it is.
I'm going to try to break downwhat I think I just heard.
So during COVID PE firms madeinvestments in funds and those
(23:25):
companies underperformed becauseCOVID sucks.
And so when they open, okay.
Someone give me like the 10sentence answer, 10 second
answer of like why theyunderperformed then.
Ed (23:37):
They, they underperformed because interest rates went up
and they overpaid for themduring COVID.
Emily (23:43):
Well, okay.
So interest rates were goingcrazy because of COVID was doing
what
Rory (23:47):
you're talking about.
Emily is actually, you know, adouble adding, calling it, it
creates a double negative.
So like Ed was talking about itas if like business is
performing just as it was, butwhat you're talking about
actually makes that even more ofa hit, like a negative, it was
like
Emily (24:02):
a double stacked against your environment.
So then when PE or when PE firmsgo LPs.
We need some more funding forthe next round.
Come on down.
They're like,
Rory (24:13):
my money's still tied up that checkbook right now.
My money's still
Emily (24:16):
tied up over here.
It's not doing so well.
So I want a discount on thisother next round.
Rory (24:22):
Yeah.
Buy one, get one at a discount.
Exactly.
Just like you'd go to thegrocery store for, you know,
whatever, whatever you like, youknow, that
Emily (24:33):
makes sense to me.
So then the PE firms go, okay,I'm going to go from 2%.
To 1.
75 on your management fee, theygo, okay, fine as a founder, I
need to be aware of that.
Is it more so for like trying toexit?
Is it more like, where does thataffect me most?
Ed (24:50):
So as a founder, it's less, the effect is less direct.
I mean, you're not beingimpacted by the LP fees.
You're not being impacted.
What you need to be aware of asa founder is that private equity
fund is under tremendouspressure to perform right now,
more pressure than they've beenunder for a decade.
(25:10):
And so
Emily (25:11):
they're going to
Ed (25:12):
structure their deal to ensure better
Rory (25:15):
performance.
Emily (25:16):
Ah, so on again, remember this is kind
Rory (25:19):
of a zero sum game.
Any gain on one side means, youknow, seeding something on the
other side.
It's, you know, you can't, it'snot a perfect hedge, right?
So
Emily (25:28):
you're going to get.
In general, statisticallyspeaking, you're going to get a
less favorable deal on your end.
Because they're going to try tomake up for it.
Rory (25:35):
Correct.
Yep.
Yep.
Exactly right.
Emily (25:38):
So they're getting crunched on the LP side.
So they're going to try to makethat up on your side.
Ed (25:43):
Yep.
On the carry.
Emily (25:46):
On the company side.
Okay.
Rory (25:47):
Yeah.
Emily (25:48):
Rory, can you break down carry?
Can you break down what edges?
Sure.
Rory (25:51):
No, it's just, we'll, we'll keep coming back to this,
you know, in, in these carrycarry simply means.
The private equity groups callit participation in the
profitability of the business.
So like if, if they, if thebusiness is sold at a really
good price, then private equitygroup participates in the
(26:16):
profits that are delivered tothe LP from that.
Deal being so good.
So like, here's the, here's howit works.
Like on my, my fund, you know,we have a, we have a
participation.
Once our investor groups hit a10 percent return.
So any, anything above a 10percent return, we participate,
it's called carried interest.
We have an interest that we havein, in our investors
(26:41):
profitability, basically.
So we share in their profits.
So
Emily (26:43):
if it hits that threshold, you get interest
payments.
Yeah.
Like are they, are they likedividends or are they just like,
you get.
Yeah.
Rory (26:51):
Yeah, exactly.
It's it's, I mean, technicallyit's just a share of the
distributions, but it's, youknow, how you, how you
characterize it, just thinkabout it as participate in the
cashflow, that's the easiest wayto think about
Emily (27:04):
it.
Now, can, do you have the optionto reinvest those in the
business or do you pocket themor do you have choices?
Rory (27:11):
Yeah, I think, well, so depending on the structure of
the fund, you know, oftentimesthere is reinvestment or at
least for a period of time, likein our Our funds, there's a,
there's a period that's just theinvestment period.
So any dividends or I should saycashflow that's available to be
distributed, gets reinvested inassets for a period of time, but
(27:31):
not forever because, you know,as an LP, eventually you want to
see, you want to see somecashflow, right?
You know, so that's, and that'sthe whole purpose of it.
So.
Yeah.
Emily (27:41):
Okay.
Okay.
I'm still trying to like, find asuccinct way to say, why are
these management fees falling?
Because it made the news.
Like, it made your
Rory (27:51):
I think it's more relevant just for people in the private
equity side of the coin.
Not, it's, as Ed said, Theimpact to founders, management
teams, people in operatingbusiness.
It's indirect.
I think it's just interestingbecause we're sort of seeing a
trend that's been different thanwhat we've seen for many, many
(28:11):
years.
And anytime you see the marketgoing rate for asset management
fees under private equitymanaged funds decrease.
That's a, that's a big thingbecause it's been such a
ubiquitous two and 20 dynamicforever.
So you just naturally want tothink about, well, what happens
now?
You know, like, what does thatmean?
Emily (28:32):
Can it go back up?
Yeah,
Rory (28:34):
absolutely.
Absolutely.
You know, one thing that'scertain about private equity and
the very, very smart people thatare in that world is they
innovate, they figure out waysto create new value, create
differentiation.
Like Ed said earlier.
You know, if you're aspecialized fund, you can
command higher fees.
Some of them, and this is kindof in hedge fund territory, but
(28:54):
I mean, some of the hedge fundfee rates are really, really
high because maybe they're, youknow, high frequency trade.
I mean, just super specializedstuff that somebody is willing
to pay for, you know, becauseit's high value and you're
delivering high returns.
At the end of the day, it's allcommensurate.
Remember this, this is as basicas it gets.
Fee structures are aligned toinvestor returns.
(29:15):
It can't be out of whack.
Otherwise there wouldn't be abusiness.
So best returns go up, then, youknow, private equity makes more
money because, you know,everyone is happy when they're
making money.
And so you can command morefees.
If it's, if it's toughenvironment to realize ROI, then
fee rates have to go down.
It's just the law of supplydemand, you know?
Emily (29:36):
So to turn the tables a little bit, if you were talking
to a PE firm or like a managingdirector of a PE firm in this
environment, and they're askingyou how to, like, what do I do,
how do I structure this, Whatadvice would you give them?
Rory (29:49):
Ed, you might take that one.
You're a master structure.
Ed (29:54):
Yeah.
Master structure.
Um, you know, if I were sittingon the other side going guys,
the right now, it is a, It is abuyer's market, um, for
businesses.
So PE firm, if you have skinniedyourself down, you may want to
go, Hey, I'll take one, one anda half percent, one and three
(30:15):
quarters on the asset managementfee, but I'm going to push the
promote up, or I'm going to pushthe carry up to 25 or, you know,
22 so that.
I'm more aligned with thelimited partner.
So I make more money when theonly one, the limited partner
makes more money, but I'm goingto make up the difference in on
the profit side.
So I'm not giving up thedollars.
(30:37):
I might just be deferring themwith a potential of a higher up
if I really perform well.
Emily (30:43):
Okay.
So I got one point higher
Rory (30:45):
upside on the percentage profit share, the carry, as we
talked about maybe lowering thehurdle rate too, for which you
start to get compensated.
I mean, a lot of times.
You know, it could run thegamut.
Like I said, our funds are like10 percent is our hurdle rate,
but I've seen funds as low asfive.
So, you know, you'll find, youknow, if you, if it's a, let's
(31:06):
just say if it's a tougherenvironment to make money
generally, then a lower hurdlerate for which then, you know,
the PE group can share in theprofits of the LPs makes sense,
it's just, you know, there's abaseline economic.
State of affairs and everythinglike, you know, risk free rate,
(31:26):
all this stuff is benchmarkedaround
Emily (31:28):
that
Rory (31:29):
effectively.
I mean, like it's all, it allworks together.
You know,
Emily (31:31):
sounds like, like you're still being incentivized.
It's in alignment with the LPit's just, yeah, I have to like
reach out.
If you're not, if you're not,there's no business around kind
of where and when that happensand how that happens.
Would you like, Ed, would yousuggest the PE firm does
anything specific with like the,the companies they're working
(31:52):
with on that side, or is it allkind of rejiggering with,
they're
Ed (31:55):
going to, they're going to be working.
Um, you know, on that side torefinance, re engineer,
renegotiate, um, renegotiatecovenants and they give
themselves some flexibility onthe debt side for their
existing, for their existingportfolio companies.
The new companies are taking on,they're going to lever, they're
going to lever them differentlyand are going to go in with a
(32:16):
different strategy that isn'tnecessarily a debt driven, uh,
debt driven strategy.
Optimization value optimizationmodel, because it may not be,
they're probably going to belooking more at what kind of
operating efficiencies, whatkind of growth, what kind of
organic growth can we get out ofthis business more so than, you
know, how much of that can wethrow on this to be able to
(32:38):
drive the return on equity up?
Rory (32:40):
Oh, I was just going to bring it back to kind of like.
Once again, talking about, youknow, the ability of an
operating company to be more andmore profitable just means more
and more value to, at the end ofthe day, the LP that's, you
know, committed, committed thecapital, the PE group who's
invested it, I mean, it all,it's all this virtuous thing.
Like, so is that saying you doall these things at the opco
(33:02):
level so that you can.
Make it more profitable for thePE group and then the PE group
can share in more profits, youknow with their circle
Emily (33:10):
of life Simba Everybody wins
Rory (33:12):
is it's a sir.
It is the circle of life forsome the circle of death, you
know You know it it is it's youknow It it is really just it's
always just these pieces movingwithin this ecosystem.
That just says okay where isWhere's the benefit going at the
end of the day, it's alwaysgoing to be aligned to the
(33:34):
benefit or at least structuredin a way that the LPs, you know,
make the money.
I mean, cause without, withouttheir money, none of
Ed (33:42):
this, nothing happened straight up at the end of the
day, though, M it's gottenharder.
So, I mean, fundamentally itused to be when you could borrow
money for 3%.
Yeah.
You go, okay, this is easy.
I'm going to, I'm going to payas little as possible.
I'm going to put some leverageon the business.
I'm going to get a good returnon equity and it's done.
And if you don't achieve theoperational efficiencies, if you
don't really grow, you can stillget a decent return out of that
(34:04):
business.
Now.
The strategy going in and wetalked about, you know, private
equity goes in with a strategy.
They're never like, well, we'regoing to buy it and see what
happens.
I'll bet you dollars to donutsat that strategy right now is
far more driven around, how dowe drive operational efficiency?
How do we drive organic growth?
How do we be capital efficientand not as much about how do I
(34:26):
throw debt on this business andservice that debt to be able to.
They kind of bring my purchaseprice down and get a higher
return on equity.
It's got to be more on theoperational side.
Emily (34:35):
So is the main form of debt in what you're talking
about a bank loan?
Rory (34:39):
Yeah, it's normally bank loans and nowadays private
credit funds.
So non bank lenders, but yeah,it's, it's the, let's just put
it this way.
Uh, Emily, the, the, that'scalled the credit markets.
The, the world of debt is ordersof magnitude bigger than the
private equity world.
It's, it's massive.
Because
Emily (34:59):
like earlier Ed said, covenants and I had like
flashbacks.
So it's like you and Rory andGlorimar and like our PE firm,
like we're going to bustcovenants.
And that was like the end of theworld.
No, it's a little bit gnarly
Rory (35:10):
at times like this, you know, you know, it's like a
little more You know, a littlebit, little hairier, you know,
but you know, yeah, but that'sjust the cycle of business.
It's a cycle of life, right?
Like it's always cyclical, butalso
Emily (35:24):
like in that the interest rate affects the bank loan as
well.
So it's kind of totally like themacro economic piece of it.
You have to be aware because ithits you in these different
points.
There was
Ed (35:34):
a, there was a lot of folks that back for the last few
years, They didn't put interestrate hedges on because they're
like, well, you know, it's goingto be fine and it costs money to
hedge your interest rates.
And so they were like, no, we'regetting, we see stability.
Well, all of a sudden theinterest rate starts taking off
and they're like, well, and ittook off fast.
I mean, the interest rates rosequickly and they ended up flat
(35:57):
footed and now they're stuckwith, you can't hedge against,
you know, they're hedging at 4%.
Didn't the
Emily (36:03):
interest rates go negative in certain countries
somehow?
Ed (36:06):
Yeah.
The, the, like the equivalent ofthe fed funds rate, but, but
yeah, the effective, theeffective interest rate was so
low that a lot of, and again,every one of these things, if
you're going, well, I'm going tohedge my interest rates, you
have to buy the hedge with thebank.
You negotiate it with the bank.
So folks are like, well, whywould I want to spend that
money?
I don't see the interest ratesgoing up anytime soon, so I'm
(36:26):
going to, it gives me a betterreturn.
Well, it's crazy.
Let's.
When he flipped that really
Rory (36:30):
greediness, like in like
Ed (36:32):
just a couple of quarters, the interest rates went way up,
like very quickly that caught anumber of companies that didn't
have a hedging strategy flatfooted.
Rory (36:41):
Yeah.
It's, you know, like it alwaysfollows the same thing.
It seems like, you know,there's, there's, there's these
cycles go to where.
You know, I don't know, likethere's a level of complacency
at a certain point.
Things are so good.
There's no way it could possiblyswing so far the other way that
we get slapped.
And then, but sure enough, itdoes.
(37:03):
And you do that's a.
That's a, I, I think correctionslike that are critical, you
know, and that, but it happens,you know, um, it just, it's,
it's, it's a normal part ofthing.
It's
Ed (37:19):
almost like every 10 years, like clockwork.
Yeah.
I was just going to say that Iwas trying
Rory (37:22):
to do the, you know, kind of, and I'm sitting here, you
know, I've got, I got gray hair,so I've
Ed (37:26):
been through like four of these and I'm like, you know,
it's about every eight to 10years, like clockwork, the, the,
the Business cycle cycles andfolks like we never saw it
coming when it were, as you'regetting old, you're like, no, I
can see this.
I see it coming.
And you guys are coming now.
Rory (37:43):
Yeah.
So you never know.
Like we could be sitting here 10years from now saying, wow,
management fees on average are4%.
Why is that?
Well, it's because.
Blackstone and KKR have acquiredevery other private equity firm
in the world.
And it's only two of them, andnow they have the pricing power.
You know, who knows?
Like, there's, there's, uh,these things can swing both ways
if you, if you want to
Emily (38:03):
think about it.
So let me like wrap this up andalmost like it's a tee up for a
future episode.
But
Rory (38:08):
yeah,
Emily (38:08):
for like the debt side.
The P.
E.
firm.
Ooh, I love talking
Rory (38:12):
about debt.
That's my favorite.
Emily (38:15):
You get so excited.
I do.
So the P.
E.
firm, when they're, when they'redoing a deal, they'll take out a
loan from A bank and the termsthey negotiate with them are key
to how the deal is structured asa, as a founder, you best be
aware of how that's structured,because if like the interest
(38:35):
rates do a whole, like arollercoaster on you, that
crunches your forecast.
And that means you're going tohave to operate differently.
So that's like a whole other, wehave a
Rory (38:43):
whole section of that in our book, you know, plug, but
yeah, But yeah, that's, that is,you know, you mentioned what's,
what's direct and indirecteffect on these businesses.
Absolutely.
The leverage that's so leverageequals that again, um, that's
placed on these businessesusually at the time of
acquisition by a PV group, that,that is directly impactful to
the founder and what they'vebeen used to 100%.
Emily (39:05):
They're at
Rory (39:06):
the
Ed (39:06):
top, they're at the top of the waterfall with the best
Vista.
Emily (39:09):
Yeah.
Well, I mean, they get, they getpaid first.
And I know that in somescenarios, like if you're, if,
if the company is not doing welland you're not able to pay back
the bank, they'll extend theloan to you, but the interest
will be higher.
And so it almost makes it worse.
And they'll
Ed (39:26):
charge you a fee for the privilege and see what the, what
the business, what the bank doesnot want.
Every
Rory (39:32):
time a covenant is waived that you've busted
Ed (39:34):
or whatever, you get charged for that.
Write a check.
Yeah.
Yeah.
What they will not, what they donot want to do, and this is a
whole nother episode is take thebusiness.
So they don't want to force youto bankruptcy.
They don't want to take thebusiness.
They don't want you to toss thekeys at them, but they will
extract every pound of fleshthat they figure they can,
including renegotiating thatloan in order to be able to make
sure they get paid back and, orby, or, and again, we've been
(39:58):
in, I've been in this situationonce where negotiated with the
bank to buy us time to get thecompany sold.
Yeah.
Rory (40:04):
Yeah.
Or basically, you know, put itto the ownership group to put in
haircut money, right?
Like to top up.
So that if that means, you know,we talk again, prefacing some of
the book, we talk about conceptslike drag along tag along, you
know, if you're, if you're in anownership group.
(40:25):
And you're, you know, you're,you're a party to a bank loan.
You know, there's, you, you mayneed to contribute more equity
at some point to, you know, um,top up if you're using a
borrowing based scenario, likethe advance rate, I mean,
that's, this is a whole notherepisode, but yes, these are
absolutely things that a founderand the manager team need to be.
aware of and understand deeply,um, in these deals.
(40:49):
So, so basically
Emily (40:50):
listener, you have gotten a preview of an upcoming
episode.
So if you would like to knowmore than tune in next time to
the private equity experiencepodcast, Ed Rory, anything, any
last thoughts on management feeor what that means or what
people should know, why that'snewsworthy.
We covered a lot.
We covered
Rory (41:08):
a lot.
We jumped around.
Um, Not really.
I think, I think, uh, yeah, Ithink it's important for us to
just kind of keep on currenttrends and look ahead.
And what does it mean for, whatdo these trends mean?
I guess that's the, that's thepoint.
Ed (41:20):
Yep.
And I think second, third layereffects of, of what you're
seeing in the headlines.
Yeah.
Emily (41:25):
Yeah.
And I think, you know, We'regoing to be doing episodes on
the trending topics.
And if one of us comes across anew story that we think is
important for you to know about,then we'll kind of discuss it as
a group here and you get tolisten in.
But,
Rory (41:36):
and if you viewer or listener have interest in things
that you're seeing and you'dlike us to expound upon, we love
doing it.
So hit us,
Emily (41:47):
shoot us a note.
All our information is in theshow notes as always.
All right.
Talk to you guys next time.
Bye.
Rory (41:54):
Bye.
If you enjoyed today's episode,please like, share, and
subscribe wherever you get yourpodcasts.
Welcome to the Private EquityExperience Podcast.
Your backstage pass to thestrategies, stories, and secrets
that drive value in the PEuniverse.
No filters, no fluff, juststraight talk and expert
insights to help you navigatethe private equity world with
confidence.
And now your hosts, Ed Barton,Rory Liebhardt, and Emily
(00:29):
Sander.
Emily (00:34):
We are back on the private equity experience
podcast and we are going to talkabout management fees.
So we talked a little bit abouthow a PE firm makes money last
episode, but Rory and Ed, whatdo you, what do I need to know?
What do we need to know aboutmanagement fees?
Rory (00:50):
Need to know I'm fresh in from Vegas.
So if I come off as a blearyeyed idiot, uh, you know, I have
an excuse for that.
It's not my normal self.
But it
Ed (00:59):
was a
Rory (00:59):
business trip.
It was a business.
There's all, it was all lots ofprivate equity related
discussions and hobnobbing.
And it was a nice
Emily (01:06):
photo of you in front of that famous fountain or
whatever.
Yeah.
Rory (01:09):
Yeah.
Yeah.
The Bellagio fountains, Bellagiofountains.
Yeah, exactly.
Yeah.
Yeah.
Ed (01:15):
You, you are, uh, You're the, the conference guy.
If I never have to go to LasVegas for a conference again,
I'll be satisfied.
Rory (01:23):
It's just one of those things that it's a necessary, I
won't say evil, but I'm too oldfor this stuff.
I went to Vegas
Emily (01:33):
for three days.
For a conference.
And I don't think I saw adaylight once.
That was how they get,
Ed (01:41):
it's brutal.
It's brutal.
Yeah.
And what you're saying, Rory'sthe truth.
And I'm that much older than youare.
You just can't.
I mean, you come back and you'relike, I need a vacation for my
man.
I remember
Rory (01:51):
when we, we used to do it together.
We used to conquer these thingsand it was a freaking marathon.
Man.
Yeah.
But that's when I used to getbuyer conferences.
Oh, my.
Ed (02:03):
Yeah.
Debt buyers know how to drink.
Um, so yeah, and God blessed.
Did I have to, I was able toback in the day, keep up, but I
can't anymore.
I
Rory (02:16):
remember Ed, one of the things you told me actually,
when I worked for you back inthat timeframe is, you know, if
you actually, I think I wasasking about, Hey, should I get
into business development andsales?
You're like, you need to learnhow to golf and you need to
learn how to drink.
And I'm not very good at eitherof those.
So maybe I'll just stick withfinance and you know, all that
stuff.
(02:36):
So
Ed (02:37):
it's a, it's a safer, it's a safer spot pays better.
Well, maybe not sales paysbetter.
Yeah.
But the two, the two crossover.
Rory (02:44):
I mean, that's, that's the, that's the magic there is
some synergy amongst that.
Yeah.
Anyway, we digress as usual.
So,
Ed (02:52):
yeah, I was, I was actually out while you were partying in
Vegas.
I, I was, I'd got somethingdropped into my lap, which was
You know, we, we talked last,as, as you said, last episode
about the, the fund structureand how private equity gets
paid.
And, you know, there's the,there's essentially the, the 2
percent of the asset managementfee.
(03:13):
And then they get, you know,essentially historically has
been a two and 22 percent of themanagement fee.
2 percent management fee everyyear for what's being managed
for assets under management.
And then the 20 percent of theprofits.
Well, not 24 hours after wefinished putting that, um,
episode in the can, I see a, Isee an article on PE wire that
(03:34):
basically says management feeshave fallen to their lowest
level since tracking began.
And you know, we're seeing,we're seeing That two is now
like one and three quarters anda 20 in some cases is even lower
than 20.
It could be in the fifteens or,or, or tens.
And I was having a, anotherdiscussion with a friend of mine
(03:56):
in private equity this last weekwho said that the funds that
were raised during raised anddeployed during.
Essentially during COVID andpost COVID 20, late 20 through
early 22 are just performinglike dog shit.
And they're having problems kindof showing return to, and to the
(04:17):
LPs are having problems raisingthe next funds.
And of course, We haven't gottento that part in kind of the
series yet, but that's howprivate equity stays alive.
And so I'm curious, you know,what kind of, whether you were
hearing anything in Vegas on, onkind of these issues and, you
know, what, if anything, Itmight portend for private
(04:37):
equity, both for founders andfor, for PE, uh, GPs and LPs,
you know, going forward.
Rory (04:45):
Well, I got a lot of questions along these lines and
had numbers discussions, notonly about, you know, what,
what, uh, you know, what doesthe economics look like for
private equity funds today,venture funds, et cetera, but
also, you know, what, what doesthe capital raising environment
like and how is that?
How's that going?
I think there's a few factors atplay, you know, one you touched
(05:07):
on it is some of these vintagefunds from pre COVID or, you
know, some of that are long inthe tooth from, you know, 21,
you know, this isn't the best M&A environment that the world has
ever seen.
Right?
So, you know, this is about thetime where that vintage is
starting to harvest and sort ofdivest and sort of take shape.
Take profits off the table andbasically start to, you know,
(05:28):
wind these funds down, move onto the next.
Now people are still raisingfunds, but they're extending the
old ones or the, the more, youknow, uh, the vintages past the
typical three to five yeartimeframe to, to longer periods.
So what does that do?
You know, that makes for alittle more fundraising
challenge because typicallyyou're LPs and like, remember
(05:51):
last episode, we talked aboutLPs being those.
Pension funds, endowments,sovereign wealth funds, you
know, insurance companies, etcetera.
And if their money's locked upin one fund, it's sometimes it's
hard to get more money out ofthem.
And I mean, anyone that's beenin the business of raising
capital, whether you're afounder and a venture backed
fund or whatever, or your, yourown operating company, if it's
(06:12):
hard to go back to the samewell, if you've not delivered
them their original investmentback, you know, so, so I think
that's put some strain, youknow, there's still a lot of
capital on the sidelines, but,um, but it's, it's, you know, in
order to, to, to raise funds inan environment like that, you,
you do need to kind of, I guess,quote unquote, get creative on
(06:35):
fee structures.
So yeah, it sounds like feeshave come down.
Some of that also, I think hasto do with scale.
The bigger you get, you know,it's just a lot of large
numbers, you know, charging 2percent on, you know, a 20
billion fund, you know, or, or100 billion fund or whatever.
Um, it starts to look much morelike a mutual fund size where
(06:56):
those fee structures are, youknow, 25 to 50 basis points,
not, you know, 200.
So there's a lot of factors atplay, but yeah, I think, you
know, for a lot of middle marketprivate equity funds, um, you
know, that could be a big.
Is it, because they're Ifthey're having to take a hit on
the fees, you know, hopefullyprofits,
Emily (07:16):
how big of a deal is it?
I mean, obviously 2%, 1.
7, 5%.
I think you said on that amountis a lot, but it was every
single deal right at 2%, or wasthere a little squishiness
around the edges?
Rory (07:30):
But there's always been, yeah, there's
Ed (07:33):
always been some squishiness and and some of the funds.
You know, Emily, if, if it's areal specialty niche, they may
be up in the 2 percent to 5percent range
Emily (07:45):
and, and
Ed (07:46):
for others where it might be a debt fund, um, or leveraged,
leveraged loan fund, they may besub 2 percent or have
historically been sub one downto 1%.
So it has varied, but the, thementality has always been, you
know, two in 22 percent for the,for the Um, kind of base
management fee and 20 percentfor the, or for the carry, the,
(08:09):
the part that's, you know, kindof based on profit.
The interesting thing isprobably, you know, 20 years
ago.
So back when I was gettingstarted, um, that two and 20
turned into two and 20 over.
So you only get your 20 percentover a hurdle rate.
So you kind of got to go, okay,it's two and 20 over 12%.
So, you know, you, once you getthe first 12 percent back to the
(08:32):
limited partners, then you startseeing your, your carried
interest or your carry start,start paying off.
And I think, you know, what,what we're seeing in the market
and I'll give a, I'll give akind of a.
Real life example here in aminute what we're seeing in a
market for my seat is like,look, the, the debt markets suck
because the interest rates arehigh or historically, they're
(08:54):
not historically high, butrelative to the last decade,
they're high.
So it's tougher, you know, kindof finance geek, you're kind of.
Pricing these things on adiscounted cashflow basis and
your discount rate or your riskpremium, or however you want to
describe the, the way you'revaluing the business is driven
by, is driven by a higherrequired return because interest
(09:17):
rates are high.
So that drives prices down.
So the market, you know, sellersare more reluctant to sell
because the valuations have gonedown.
Companies who are bought whenthe, Interest rates were 1%.
Now interest rates are five or 6percent are going, you know,
our, the company's got lessvalue, even if we've grown it,
it may have less value todaythan it did when we bought it.
(09:39):
So it's tough for the PE guys toget out of those companies or
certainly get out of it at aprofit and the.
The leverage piece that theyuse.
So when they do the financialengineering and throw some debt
on for the acquisition, that,that carry is getting more and
more expensive, which reducescashflow.
So, I mean, it's, it's kind ofa, uh, I don't want to say it's
(10:00):
a perfect storm, but it's a,it's a rough market out there
and the, the LPs are going, Hey,we, we want, it's our money.
We want our share.
And yeah, you might not beseeing a lot of that promote
because you're not going to hitthe 12.
Bye.
On the next fund, you know, youowe back to us a little bit.
And so we, we're going to takethat, you know, that why is the
(10:21):
distinction
Emily (10:22):
between the debt market important?
Ed (10:24):
So the debt market, the debt market does two things.
And, and the, the first thingkind of as a practical matter,
the first thing is.
A lot of the private equityfunds will borrow a portion of a
purchase price.
And so, and they, when they buythe company, they go, Hey, we're
going to use some of thecashflow from the operating
business to pay this debt down.
(10:46):
Yeah.
But a service to debt.
Well, most of the time that debtisn't like, you know, if you go
buy a house, you got a fixedrate mortgage, it isn't fixed
rate.
It's variable rate.
And they may or may not havehedged.
You put a, put a hedge on toprotect their interest rate
exposure.
So in some cases or interestpayments may have gone from 80,
(11:07):
000 a month to 270, 000 a monthover the last few years as
interest rates have risen, whichcomes out of the operating
cashflow of that business, whichlimits our ability to reinvest,
to grow, you know, to, to spinoff dividends.
So that's one piece.
The second piece is.
A principle of valuation of anycompany is kind of this concept
(11:28):
of, I've got to get a certainreturn.
And that certain return isagain, going to like finance
theory, a risk free rate, plusthe, plus the risk premium based
upon the riskiness of thatparticular asset.
Well, if the risk free rateThat's kind of driven by the
bond market, the government bondmarket.
So if government bonds have gonefrom a quarter point to two and
(11:51):
a half percent, the requiredreturn goes up by that same
amount by, you know, another twoand a quarter percent.
And so now the discount rateshigher and the business's
valuation goes down, even if thebusiness is doing just as well
or better, the valuation goesdown.
Rory (12:06):
Translation.
Not the greatest thing in theworld to founders, management
teams, looking for somecompensation on a company
valuation.
And not right now, in a waythere's a lot more, uh, cooks in
the kitchen and there's a lotmore hurdles to be cleared
before you see that dough, uh,you know, down the waterfall, as
you say.
So, yeah, I mean, so kind ofgoing back to that comp and, you
(12:29):
know, compensation piece of it,you hit it like, you know, the,
the, the, the firms that have aspecialization.
Can still command the highermanagement fee.
Like, um, you know, I have acouple of, I guess you would
call them, uh, closed end,private equity funds that
acquire assets that are inbankruptcy.
So we do something extremelynichey.
(12:52):
We're able to charge, you know,two and a half percent, but, you
know, we have investors that'llsee headlines like what you
talked about and say.
You know, uh, I I'm seeing nowthat the going rate for AUM fees
is one, one and three quarters.
So like, why are you chargingtwo and a half?
So that, that becomes adiscussion that a fledgling, you
know, fun like ours has tonavigate.
(13:14):
Whereas people see kind of thesemacro trends and like look at it
and compare it to a, you know, aquarter, quarter trillion dollar
fund.
You know, it's, it's a, it's aBritish it's it, this doesn't
bode well for optics aroundsmall.
Funds like this.
So it's you got to specialize.
Um, and that's, that's key inorder to be able to kind of
Emily (13:36):
like the standard is changing.
It sounds like
Rory (13:39):
it's, it is more at a rat more rapid clip perhaps now than
it had been is, you know, it'salways kind of been this.
Baseline two and 20 concept iswe've talked about that seems to
have been the standard for many,many, I mean, decades even.
Um, but yeah, now it's just,it's, you know, there's, there's
different shifts in leverage,right.
And in which side of the dealyou're on.
(14:00):
So, um, right now LPs have thecapital, um, and there's more
choice.
And so, you know, the sponsors,i.
e.
the private equity funds have tomake concessions.
That's just how it goes, youknow?
So,
Emily (14:15):
so how does this compare with like the deals that, um,
We've been a part of, or you twohave been a part of, like, you
mentioned the differentstructure.
I mean, what do you have tostructure differently?
Rory (14:25):
So there's a, there's a few things I think, like in this
particular article that we werelooking at, you know, I think
that the denominator for which,The fees are measured against,
you know, is the commitmentamount, right?
So if, if a LP commits a hundredmillion dollars to a strategy,
(14:47):
in this case, we're talkingabout charging one and three
quarters percent against thatcommitted a hundred million.
What's the difference betweencommitted and called it means if
I've signed on the dotted lineas a commitment, it means that
I'm reserving capital to becalled by the private equity
group at any point in timecalled means, Hey, we're going
to go buy a deal.
(15:08):
You need to fund yourcommitment.
So, so different flavors dictatekind of how the fee structure
works.
I think like.
The charging fees on thecommitment itself is very
private equity fund friendly,not as friendly to the LP.
Whereas other, other strategiessay, we're only going to charge
you a management fee on thecapital we call.
(15:30):
I mean, that's what my funddoes.
We, we don't call, we don'tcharge a management fee on
commitments.
We put it on ourselves to say,if, if, if, if, if, if, if, If
we don't do deals, we're notearning a fee.
So, you know, there's differentflavors of that.
So two and a half percent thatwe charge.
Might sound high, but it'slower, relatively speaking in
(15:51):
the event that, you know, we'recompared against some that are
not actually calling all thecapital deploy and deals.
And so we talk about the M and aenvironment.
The reason you're not, there'sjust not as many deals
happening.
So they're not as much capitalbeing called.
So private equity funds aresaying, Hey, we recognize that
we're not calling and investingas much of your capital.
Maybe in this, this case forthis fund.
(16:13):
We'll seed the rate on what wecharge so that you don't, your
capital doesn't fly from ourfund to some other strategy, you
know?
Emily (16:20):
Holy cow.
Okay.
So like if I'm a founder, I amlike thinking about this at a
couple of different levels, likelike macro economics.
It's like, what is the marketdoing?
Like what are interest ratesdoing?
Um, or is there any like crazyevents happening that would move
the market at that level?
And then it's like, what PE fundam I working with?
Are they Are they large, medium,small?
(16:42):
Are they boutique orspecialized?
Who makes up their LPs?
And what are, what, what'shappening at that level?
And then of course, for what'simportant to me as a founder is
like, how does that affect mydeal structure and how the PEs?
Exactly right.
Rory (16:58):
Yeah.
I think what you're hitting onis really important for a
founder and management, again,working with a founder and these
operating businesses, like Youknow, what is that dynamic
behind my potential investor?
Right?
Like my potential privateequity, what is their dynamic
look like?
You know, you know, look like ifyou're, if you're dealing with
an Apollo, you know, there'snothing to worry about, they're
(17:18):
pretty solid, but if you'redealing with a fledgling, you
know, um, PE group, that's sortof at the table, maybe, you
know, really aggressivelycourting you, but it's hard to
say.
Just how, you know, how, howdeep of a track record they
have, what their LP situationis, that's something to be
cognizant of for sure, becauseyour success is going to be
based on their success.
(17:38):
I was going to
Ed (17:39):
say two other things to keep in mind from a timing
perspective right now is, um,You know, as I had mentioned,
the, the purchases that theymade during COVID, so 2021, 22,
before interest rates started torise, they're underperforming on
balance.
So if you can, so if you canafford to not sell again, a
(18:00):
Pete, the private equity guyshave long term relationships
with their limited partners.
And if they got a couple offunds that aren't doing well,
they're going to be looking toget.
Their next fund to do reallywell.
So they're less likely to bepaying you top dollar.
They're less likely to, to be asaggressive.
They need to get deals done, butthey're going to be looking to
(18:21):
hit long ball on this stuffversus versus small ball on the
other.
Emily (18:27):
Can you outline like a, at a high level?
What a deal looked like preCOVID or during COVID and then
do one for now.
Ed (18:35):
Yeah, I'll, I'll give an example.
We, we were working on a deal.
I was working on a deal with a,with a family office out of the
Bay area about almost two yearsago.
And we were prepared to pay like16 X EBITDA on a, on a
manufacturing and distributionbusiness, which again, made me a
(18:56):
little bit, You know, as a, as ahardcore finance guy, a little
bit, yeah, but we did not getthat deal.
We were outbid by a privateequity firm.
Yeah.
We were outbid by a privateequity firm.
So it was a, it was a familyoffice and it was, and we were
outbid by a private equity firm.
That same deal today wouldn'ttrade at more than 11.
Emily (19:15):
And I'll bet you
Ed (19:16):
it would possibly be single digits and the folks who bought
it are not happy.
We happen to, you know, maintaincontact with a couple of managed
members of the management teamand you know, they're, they're
not happy.
And the issue there is, youknow, in order to get the deals
done, there was a lot of capitalrunning around, interest rates
were low and folks were tryingto get.
(19:38):
Capital deployed.
And so they're like, okay, well,we'll, we'll buy with the
anticipation that growth isgoing to continue.
Well, you know, the economyslowed a bit, interest rates
have risen, their carry cost hasgone up.
And now that business is worthsignificantly less.
And again, if you go from 17, 18X down to nine X.
That business, the same businessperforming the same way, the
(19:59):
value has dropped in half.
So are we still, are we still
Emily (20:03):
talking, are we still talking about the management fee
or, or the fact that PE firmshave different funds that are
open?
Well,
Ed (20:10):
well Pete, so it's a combination of things.
So let me take a step back.
These funds that were opened.
In 2021, 22 are underperformingtoday.
So when the PE guys are goinghat in hand to their limited
partners are going, we needmoney for the next fund.
Yes.
The limited partners are goingto, they're saying two things.
One, those other funds aren'tperforming well.
Emily (20:33):
Yes.
Ed (20:34):
So you need to cut me a deal on this one because I'm not
making as much.
And two, whatever you're doingin this fund had better be
better.
Better than the crap you did inthese last couple of funds.
And so if you were a founderfounding management team, this
is probably not the ideal timeto be selling.
(20:55):
Because the private equity folksneed to be able to kind of
recover their performance, hittheir performance targets.
They need to pay less.
The interest rates are up.
So they're going to be, themultiples have gone down.
And as a, as a management teammember, you may be better off
going, okay, can I, can I pushthrough for another year or two
(21:15):
until interest rates come downbefore I go to market?
Rory (21:21):
Yeah.
So, I mean, that speaks to a fewthings, you know, um, private
equity.
Again, you think about thesethings as I'm buying company, a
company, B company C on a, youthink about it on like a
singular basis.
But at the end of the day, theseare parts of a portfolio.
So these, these, these, thesecumulative deals are looked at
as part of an overall portfolio.
(21:42):
So if you're over performing onone part of your portfolio,
you're trying to make that upon, let's say, investments today
that offset that.
Right.
So ergo, you're paying, you'retrying to buy deals.
At a steeper discount basically.
Um, and so, you know, for, for,you know, touch, you touched on
(22:03):
sort of the environment spell,maybe not ideal, but shoot, it's
still more ideal than trying togo public right now.
You know, that's right up.
So I think the theme that we've,we've talked about in our book
and we touched on even last,last podcast, I think a little
bit was like private equitystill is in many ways.
The most frictionless way torealize value on a business
(22:25):
you've built, you know, so Allof that to say like the private
equity group's always going tobe trying to You know figure out
how to make their own money bothon the LP side and the
investment side Because theymake most of their money, of
course still on theprofitability of these
businesses so, you know, it allworks together, but I just think
that right now is an interestingtime because You know, we have
(22:46):
been in this high interest rateenvironment, you know, political
uncertainty a lot, a lot ofmoney on the sidelines still,
but you know, it's almost likethe skids need to be greased to
get the whole system working asefficiently as we've been used
to over the last top 10 to 15years, really, you know?
Emily (23:04):
Okay.
So if I'm a founder and now Iunderstand, all right, I kind of
have to be aware of what'shappening.
Not like directly impacting me,but like indirectly it is.
I'm going to try to break downwhat I think I just heard.
So during COVID PE firms madeinvestments in funds and those
(23:25):
companies underperformed becauseCOVID sucks.
And so when they open, okay.
Someone give me like the 10sentence answer, 10 second
answer of like why theyunderperformed then.
Ed (23:37):
They, they underperformed because interest rates went up
and they overpaid for themduring COVID.
Emily (23:43):
Well, okay.
So interest rates were goingcrazy because of COVID was doing
what
Rory (23:47):
you're talking about.
Emily is actually, you know, adouble adding, calling it, it
creates a double negative.
So like Ed was talking about itas if like business is
performing just as it was, butwhat you're talking about
actually makes that even more ofa hit, like a negative, it was
like
Emily (24:02):
a double stacked against your environment.
So then when PE or when PE firmsgo LPs.
We need some more funding forthe next round.
Come on down.
They're like,
Rory (24:13):
my money's still tied up that checkbook right now.
My money's still
Emily (24:16):
tied up over here.
It's not doing so well.
So I want a discount on thisother next round.
Rory (24:22):
Yeah.
Buy one, get one at a discount.
Exactly.
Just like you'd go to thegrocery store for, you know,
whatever, whatever you like, youknow, that
Emily (24:33):
makes sense to me.
So then the PE firms go, okay,I'm going to go from 2%.
To 1.
75 on your management fee, theygo, okay, fine as a founder, I
need to be aware of that.
Is it more so for like trying toexit?
Is it more like, where does thataffect me most?
Ed (24:50):
So as a founder, it's less, the effect is less direct.
I mean, you're not beingimpacted by the LP fees.
You're not being impacted.
What you need to be aware of asa founder is that private equity
fund is under tremendouspressure to perform right now,
more pressure than they've beenunder for a decade.
(25:10):
And so
Emily (25:11):
they're going to
Ed (25:12):
structure their deal to ensure better
Rory (25:15):
performance.
Emily (25:16):
Ah, so on again, remember this is kind
Rory (25:19):
of a zero sum game.
Any gain on one side means, youknow, seeding something on the
other side.
It's, you know, you can't, it'snot a perfect hedge, right?
So
Emily (25:28):
you're going to get.
In general, statisticallyspeaking, you're going to get a
less favorable deal on your end.
Because they're going to try tomake up for it.
Rory (25:35):
Correct.
Yep.
Yep.
Exactly right.
Emily (25:38):
So they're getting crunched on the LP side.
So they're going to try to makethat up on your side.
Ed (25:43):
Yep.
On the carry.
Emily (25:46):
On the company side.
Okay.
Rory (25:47):
Yeah.
Emily (25:48):
Rory, can you break down carry?
Can you break down what edges?
Sure.
Rory (25:51):
No, it's just, we'll, we'll keep coming back to this,
you know, in, in these carrycarry simply means.
The private equity groups callit participation in the
profitability of the business.
So like if, if they, if thebusiness is sold at a really
good price, then private equitygroup participates in the
(26:16):
profits that are delivered tothe LP from that.
Deal being so good.
So like, here's the, here's howit works.
Like on my, my fund, you know,we have a, we have a
participation.
Once our investor groups hit a10 percent return.
So any, anything above a 10percent return, we participate,
it's called carried interest.
We have an interest that we havein, in our investors
(26:41):
profitability, basically.
So we share in their profits.
So
Emily (26:43):
if it hits that threshold, you get interest
payments.
Yeah.
Like are they, are they likedividends or are they just like,
you get.
Yeah.
Rory (26:51):
Yeah, exactly.
It's it's, I mean, technicallyit's just a share of the
distributions, but it's, youknow, how you, how you
characterize it, just thinkabout it as participate in the
cashflow, that's the easiest wayto think about
Emily (27:04):
it.
Now, can, do you have the optionto reinvest those in the
business or do you pocket themor do you have choices?
Rory (27:11):
Yeah, I think, well, so depending on the structure of
the fund, you know, oftentimesthere is reinvestment or at
least for a period of time, likein our Our funds, there's a,
there's a period that's just theinvestment period.
So any dividends or I should saycashflow that's available to be
distributed, gets reinvested inassets for a period of time, but
(27:31):
not forever because, you know,as an LP, eventually you want to
see, you want to see somecashflow, right?
You know, so that's, and that'sthe whole purpose of it.
So.
Yeah.
Emily (27:41):
Okay.
Okay.
I'm still trying to like, find asuccinct way to say, why are
these management fees falling?
Because it made the news.
Like, it made your
Rory (27:51):
I think it's more relevant just for people in the private
equity side of the coin.
Not, it's, as Ed said, Theimpact to founders, management
teams, people in operatingbusiness.
It's indirect.
I think it's just interestingbecause we're sort of seeing a
trend that's been different thanwhat we've seen for many, many
(28:11):
years.
And anytime you see the marketgoing rate for asset management
fees under private equitymanaged funds decrease.
That's a, that's a big thingbecause it's been such a
ubiquitous two and 20 dynamicforever.
So you just naturally want tothink about, well, what happens
now?
You know, like, what does thatmean?
Emily (28:32):
Can it go back up?
Yeah,
Rory (28:34):
absolutely.
Absolutely.
You know, one thing that'scertain about private equity and
the very, very smart people thatare in that world is they
innovate, they figure out waysto create new value, create
differentiation.
Like Ed said earlier.
You know, if you're aspecialized fund, you can
command higher fees.
Some of them, and this is kindof in hedge fund territory, but
(28:54):
I mean, some of the hedge fundfee rates are really, really
high because maybe they're, youknow, high frequency trade.
I mean, just super specializedstuff that somebody is willing
to pay for, you know, becauseit's high value and you're
delivering high returns.
At the end of the day, it's allcommensurate.
Remember this, this is as basicas it gets.
Fee structures are aligned toinvestor returns.
(29:15):
It can't be out of whack.
Otherwise there wouldn't be abusiness.
So best returns go up, then, youknow, private equity makes more
money because, you know,everyone is happy when they're
making money.
And so you can command morefees.
If it's, if it's toughenvironment to realize ROI, then
fee rates have to go down.
It's just the law of supplydemand, you know?
Emily (29:36):
So to turn the tables a little bit, if you were talking
to a PE firm or like a managingdirector of a PE firm in this
environment, and they're askingyou how to, like, what do I do,
how do I structure this, Whatadvice would you give them?
Rory (29:49):
Ed, you might take that one.
You're a master structure.
Ed (29:54):
Yeah.
Master structure.
Um, you know, if I were sittingon the other side going guys,
the right now, it is a, It is abuyer's market, um, for
businesses.
So PE firm, if you have skinniedyourself down, you may want to
go, Hey, I'll take one, one anda half percent, one and three
(30:15):
quarters on the asset managementfee, but I'm going to push the
promote up, or I'm going to pushthe carry up to 25 or, you know,
22 so that.
I'm more aligned with thelimited partner.
So I make more money when theonly one, the limited partner
makes more money, but I'm goingto make up the difference in on
the profit side.
So I'm not giving up thedollars.
(30:37):
I might just be deferring themwith a potential of a higher up
if I really perform well.
Emily (30:43):
Okay.
So I got one point higher
Rory (30:45):
upside on the percentage profit share, the carry, as we
talked about maybe lowering thehurdle rate too, for which you
start to get compensated.
I mean, a lot of times.
You know, it could run thegamut.
Like I said, our funds are like10 percent is our hurdle rate,
but I've seen funds as low asfive.
So, you know, you'll find, youknow, if you, if it's a, let's
(31:06):
just say if it's a tougherenvironment to make money
generally, then a lower hurdlerate for which then, you know,
the PE group can share in theprofits of the LPs makes sense,
it's just, you know, there's abaseline economic.
State of affairs and everythinglike, you know, risk free rate,
(31:26):
all this stuff is benchmarkedaround
Emily (31:28):
that
Rory (31:29):
effectively.
I mean, like it's all, it allworks together.
You know,
Emily (31:31):
sounds like, like you're still being incentivized.
It's in alignment with the LPit's just, yeah, I have to like
reach out.
If you're not, if you're not,there's no business around kind
of where and when that happensand how that happens.
Would you like, Ed, would yousuggest the PE firm does
anything specific with like the,the companies they're working
(31:52):
with on that side, or is it allkind of rejiggering with,
they're
Ed (31:55):
going to, they're going to be working.
Um, you know, on that side torefinance, re engineer,
renegotiate, um, renegotiatecovenants and they give
themselves some flexibility onthe debt side for their
existing, for their existingportfolio companies.
The new companies are taking on,they're going to lever, they're
going to lever them differentlyand are going to go in with a
(32:16):
different strategy that isn'tnecessarily a debt driven, uh,
debt driven strategy.
Optimization value optimizationmodel, because it may not be,
they're probably going to belooking more at what kind of
operating efficiencies, whatkind of growth, what kind of
organic growth can we get out ofthis business more so than, you
know, how much of that can wethrow on this to be able to
(32:38):
drive the return on equity up?
Rory (32:40):
Oh, I was just going to bring it back to kind of like.
Once again, talking about, youknow, the ability of an
operating company to be more andmore profitable just means more
and more value to, at the end ofthe day, the LP that's, you
know, committed, committed thecapital, the PE group who's
invested it, I mean, it all,it's all this virtuous thing.
Like, so is that saying you doall these things at the opco
(33:02):
level so that you can.
Make it more profitable for thePE group and then the PE group
can share in more profits, youknow with their circle
Emily (33:10):
of life Simba Everybody wins
Rory (33:12):
is it's a sir.
It is the circle of life forsome the circle of death, you
know You know it it is it's youknow It it is really just it's
always just these pieces movingwithin this ecosystem.
That just says okay where isWhere's the benefit going at the
end of the day, it's alwaysgoing to be aligned to the
(33:34):
benefit or at least structuredin a way that the LPs, you know,
make the money.
I mean, cause without, withouttheir money, none of
Ed (33:42):
this, nothing happened straight up at the end of the
day, though, M it's gottenharder.
So, I mean, fundamentally itused to be when you could borrow
money for 3%.
Yeah.
You go, okay, this is easy.
I'm going to, I'm going to payas little as possible.
I'm going to put some leverageon the business.
I'm going to get a good returnon equity and it's done.
And if you don't achieve theoperational efficiencies, if you
don't really grow, you can stillget a decent return out of that
(34:04):
business.
Now.
The strategy going in and wetalked about, you know, private
equity goes in with a strategy.
They're never like, well, we'regoing to buy it and see what
happens.
I'll bet you dollars to donutsat that strategy right now is
far more driven around, how dowe drive operational efficiency?
How do we drive organic growth?
How do we be capital efficientand not as much about how do I
(34:26):
throw debt on this business andservice that debt to be able to.
They kind of bring my purchaseprice down and get a higher
return on equity.
It's got to be more on theoperational side.
Emily (34:35):
So is the main form of debt in what you're talking
about a bank loan?
Rory (34:39):
Yeah, it's normally bank loans and nowadays private
credit funds.
So non bank lenders, but yeah,it's, it's the, let's just put
it this way.
Uh, Emily, the, the, that'scalled the credit markets.
The, the world of debt is ordersof magnitude bigger than the
private equity world.
It's, it's massive.
Because
Emily (34:59):
like earlier Ed said, covenants and I had like
flashbacks.
So it's like you and Rory andGlorimar and like our PE firm,
like we're going to bustcovenants.
And that was like the end of theworld.
No, it's a little bit gnarly
Rory (35:10):
at times like this, you know, you know, it's like a
little more You know, a littlebit, little hairier, you know,
but you know, yeah, but that'sjust the cycle of business.
It's a cycle of life, right?
Like it's always cyclical, butalso
Emily (35:24):
like in that the interest rate affects the bank loan as
well.
So it's kind of totally like themacro economic piece of it.
You have to be aware because ithits you in these different
points.
There was
Ed (35:34):
a, there was a lot of folks that back for the last few
years, They didn't put interestrate hedges on because they're
like, well, you know, it's goingto be fine and it costs money to
hedge your interest rates.
And so they were like, no, we'regetting, we see stability.
Well, all of a sudden theinterest rate starts taking off
and they're like, well, and ittook off fast.
I mean, the interest rates rosequickly and they ended up flat
(35:57):
footed and now they're stuckwith, you can't hedge against,
you know, they're hedging at 4%.
Didn't the
Emily (36:03):
interest rates go negative in certain countries
somehow?
Ed (36:06):
Yeah.
The, the, like the equivalent ofthe fed funds rate, but, but
yeah, the effective, theeffective interest rate was so
low that a lot of, and again,every one of these things, if
you're going, well, I'm going tohedge my interest rates, you
have to buy the hedge with thebank.
You negotiate it with the bank.
So folks are like, well, whywould I want to spend that
money?
I don't see the interest ratesgoing up anytime soon, so I'm
(36:26):
going to, it gives me a betterreturn.
Well, it's crazy.
Let's.
When he flipped that really
Rory (36:30):
greediness, like in like
Ed (36:32):
just a couple of quarters, the interest rates went way up,
like very quickly that caught anumber of companies that didn't
have a hedging strategy flatfooted.
Rory (36:41):
Yeah.
It's, you know, like it alwaysfollows the same thing.
It seems like, you know,there's, there's, there's these
cycles go to where.
You know, I don't know, likethere's a level of complacency
at a certain point.
Things are so good.
There's no way it could possiblyswing so far the other way that
we get slapped.
And then, but sure enough, itdoes.
(37:03):
And you do that's a.
That's a, I, I think correctionslike that are critical, you
know, and that, but it happens,you know, um, it just, it's,
it's, it's a normal part ofthing.
It's
Ed (37:19):
almost like every 10 years, like clockwork.
Yeah.
I was just going to say that Iwas trying
Rory (37:22):
to do the, you know, kind of, and I'm sitting here, you
know, I've got, I got gray hair,so I've
Ed (37:26):
been through like four of these and I'm like, you know,
it's about every eight to 10years, like clockwork, the, the,
the Business cycle cycles andfolks like we never saw it
coming when it were, as you'regetting old, you're like, no, I
can see this.
I see it coming.
And you guys are coming now.
Rory (37:43):
Yeah.
So you never know.
Like we could be sitting here 10years from now saying, wow,
management fees on average are4%.
Why is that?
Well, it's because.
Blackstone and KKR have acquiredevery other private equity firm
in the world.
And it's only two of them, andnow they have the pricing power.
You know, who knows?
Like, there's, there's, uh,these things can swing both ways
if you, if you want to
Emily (38:03):
think about it.
So let me like wrap this up andalmost like it's a tee up for a
future episode.
But
Rory (38:08):
yeah,
Emily (38:08):
for like the debt side.
The P.
E.
firm.
Ooh, I love talking
Rory (38:12):
about debt.
That's my favorite.
Emily (38:15):
You get so excited.
I do.
So the P.
E.
firm, when they're, when they'redoing a deal, they'll take out a
loan from A bank and the termsthey negotiate with them are key
to how the deal is structured asa, as a founder, you best be
aware of how that's structured,because if like the interest
(38:35):
rates do a whole, like arollercoaster on you, that
crunches your forecast.
And that means you're going tohave to operate differently.
So that's like a whole other, wehave a
Rory (38:43):
whole section of that in our book, you know, plug, but
yeah, But yeah, that's, that is,you know, you mentioned what's,
what's direct and indirecteffect on these businesses.
Absolutely.
The leverage that's so leverageequals that again, um, that's
placed on these businessesusually at the time of
acquisition by a PV group, that,that is directly impactful to
the founder and what they'vebeen used to 100%.
Emily (39:05):
They're at
Rory (39:06):
the
Ed (39:06):
top, they're at the top of the waterfall with the best
Vista.
Emily (39:09):
Yeah.
Well, I mean, they get, they getpaid first.
And I know that in somescenarios, like if you're, if,
if the company is not doing welland you're not able to pay back
the bank, they'll extend theloan to you, but the interest
will be higher.
And so it almost makes it worse.
And they'll
Ed (39:26):
charge you a fee for the privilege and see what the, what
the business, what the bank doesnot want.
Every
Rory (39:32):
time a covenant is waived that you've busted
Ed (39:34):
or whatever, you get charged for that.
Write a check.
Yeah.
Yeah.
What they will not, what they donot want to do, and this is a
whole nother episode is take thebusiness.
So they don't want to force youto bankruptcy.
They don't want to take thebusiness.
They don't want you to toss thekeys at them, but they will
extract every pound of fleshthat they figure they can,
including renegotiating thatloan in order to be able to make
sure they get paid back and, orby, or, and again, we've been
(39:58):
in, I've been in this situationonce where negotiated with the
bank to buy us time to get thecompany sold.
Yeah.
Rory (40:04):
Yeah.
Or basically, you know, put itto the ownership group to put in
haircut money, right?
Like to top up.
So that if that means, you know,we talk again, prefacing some of
the book, we talk about conceptslike drag along tag along, you
know, if you're, if you're in anownership group.
(40:25):
And you're, you know, you're,you're a party to a bank loan.
You know, there's, you, you mayneed to contribute more equity
at some point to, you know, um,top up if you're using a
borrowing based scenario, likethe advance rate, I mean,
that's, this is a whole notherepisode, but yes, these are
absolutely things that a founderand the manager team need to be.
aware of and understand deeply,um, in these deals.
(40:49):
So, so basically
Emily (40:50):
listener, you have gotten a preview of an upcoming
episode.
So if you would like to knowmore than tune in next time to
the private equity experiencepodcast, Ed Rory, anything, any
last thoughts on management feeor what that means or what
people should know, why that'snewsworthy.
We covered a lot.
We covered
Rory (41:08):
a lot.
We jumped around.
Um, Not really.
I think, I think, uh, yeah, Ithink it's important for us to
just kind of keep on currenttrends and look ahead.
And what does it mean for, whatdo these trends mean?
I guess that's the, that's thepoint.
Ed (41:20):
Yep.
And I think second, third layereffects of, of what you're
seeing in the headlines.
Yeah.
Emily (41:25):
Yeah.
And I think, you know, We'regoing to be doing episodes on
the trending topics.
And if one of us comes across anew story that we think is
important for you to know about,then we'll kind of discuss it as
a group here and you get tolisten in.
But,
Rory (41:36):
and if you viewer or listener have interest in things
that you're seeing and you'dlike us to expound upon, we love
doing it.
So hit us,
Emily (41:47):
shoot us a note.
All our information is in theshow notes as always.
All right.
Talk to you guys next time.
Bye.
Rory (41:54):
Bye.
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