Posts Tagged ‘Institutional Investor’

The Changes within the Private Equity Revenue Landscape

Tuesday, May 27th, 2008

Over the last few years, Private Equity and more specifically the revenue channel of certain Private Equity Funds has changed drastically.  In the past Private Equity firms have always charged a management fee and a performance fee similar to the fee structure of Hedge Funds. The performance fee was usually collected after a capital transaction occurred, such as a portfolio company being sold.

In the last few years, however, some Private Equity Funds have come to realize that two sources of revenue were not enough, and just as important the ability to pay large bonuses only after a capital transaction occurred made these funds less attractive places to work in the eyes of many professionals. Therefore, a few Private Equity funds created an additional revenue source, usually defined as a Special Dividend. 

This Special Dividend is structured to be paid to the company’s owners (the Private Equity Funds), as defined within the initial transaction paperwork.  For instance, it could be paid on the day that the first transaction closed, i.e. the day that the Private Equity Fund bought the company, which in many cases creates a nice one day return.

Another method allows for payment at a set upon date within the life span of the ownership of the company, or if certain goals/targets are reached.  For instance, the dividend could be paid towards the end of a given year, providing the fund some concrete return numbers to show their investors or potential investors while maintaining ownership in the company.  From the Investors perspective they are seeing a return on their money rather then sitting on hypothetical numbers.

For certain investors this new revenue source is seen as a positive concept allowing their Private Equity Funds to wait longer on creating value within their portfolio company, or to wait for better market conditions to sell their portfolio company then was previously possible.  This additional source of revenue enables the Private Equity fund to have more money which can then go back into the portfolio company if the PE fund feels this is necessary. Instead of the portfolio company having to maintain the cash in their accounts, the Fund may now use to their discretion; the revenue channel to help the portfolio company better perform.

Critics argue that these special dividends are just a way for the professionals at the PE fund to receive more compensation, and cause the Private Equity Fund’s performance numbers to look better in the short run.  With their being less risk on the part of the PE Fund, since the fund has basically been paid back a portion of their initial investment, the Private Equity fund may not be as vigilant with their investment.

In many cases to pay this Special Dividend the companies must take on additional debt to make the payment, this applies more debt to the new company’s balance sheet, which in most cases is not viewed upon positively except by those individuals who received the Special Dividend.  This is one of the most controversial aspects of this new revenue source, who does it really help?

Although this source of revenue creation is new and is being implemented by a very small portion of funds it will be very interesting to see how it emerges in the Private Equity space.  The real question is; “Is it here to stay?”  It is probably too soon for us to make a fully educated answer to this question but unless the large Institutional Investors start to object I would guess that it is and likely will become a greater portion of deals to come. 

This is especially true in the case of very large deals where being able to take money off/out of the deal on day one helps to lower the risk for the Private Equity Fund while not diluting their ownership in the portfolio company.  Furthermore this revenue allows the Private Equity Fund to return money to their investors making the investor happy with a return of capital and the Private Equity Fund’s employees are happy with an additional transactional bonus being given to certain individuals within the fund.

I would be very interested to hear from Private Equity professionals and Investors; how do you view implementing a Special Dividend revenue channel? Do they out weigh the fiduciary responsibilities of the fund or is this a concept that will be looked back upon in the future as having had a negative impact on the market?

I ask for individuals to post their thoughts in our comment section of the blog or email me directly.

What is a Hedge Fund?

Wednesday, May 7th, 2008

I recently attended a Hedge Fund conference where this question was asked to a panel of five Senior Institutional Investors by the panel’s moderator also a senior Institutional Investor. After a moment of silence numerous points were made but no single clarified definition was formulated. The moderator of the group who had asked the question made this comment:  A hedge fund is technically any investment strategy that is not long only.

The panel proceeded to add a few of their own thoughts:

  • Any investment strategy where investors pay a performance fee


  • Any investment strategy where the investor’s investment is locked into the fund for at least 6 months


  • Any investment strategy excluding real estate and private equity


  • Any investment strategy uncorrelated to the markets - equity or fixed income


  • Any investment strategy which can only be invested in by accredited investors


After awhile this question was left open and the panel proceeded to discuss many other interesting perspectives regarding Hedge Funds in the institutional investor space.  The one perspective that really caught my attention was the fact that these large institutional investors viewed what hedge funds do for their portfolio in many different ways. 

The majority of the panel viewed Hedge Funds as a way to generate additional alpha which may or may not be correlated to the markets.  Another group viewed Hedge Funds purely as products which should be benchmarked against fixed income returns and the funds should provide low volatility and absolute returns.

Obviously what a Hedge Fund is and what a Hedge Fund is supposed to accomplish is a question with no one correct answer, but then how are we suppose to identify a Hedge Fund in the marketplace?

So now I ask the question to you; what is a Hedge Fund? I look forward to reading your responses