Fee load or the promote: which line would you actually fight over

Question

Two LPAs open in front of me right now, both value-add multifamily, both around a three to five year stated hold, both from sponsors I have taken seriously enough to call references on.

Sponsor A: 2 percent acquisition fee, 1.5 percent annual asset management fee on invested equity, 8 percent pref, 70/30 above it, no catch-up.

Sponsor B: no acquisition fee, 1 percent AM fee, 10 percent pref, then a 50/50 catch-up until the GP has 20 percent of profits, then 80/20.

I ran both against a middling outcome, call it a 13 percent gross deal IRR, and they land within about 60 basis points of each other on net LP return. Under a good outcome, say 20 percent gross, B keeps more of the upside from me because of the catch-up. Under a weak outcome where the pref accrues and barely gets paid, A has already taken cash out of my equity through the acquisition fee before anything happens.

So the argument for pushing on fees is that fees are certain and the promote is contingent. The argument for pushing on the promote is that fee dollars are small in absolute terms and the split is where a good deal actually gets divided. And there's a third view I've heard from two people, that neither matters next to how much of the GP's own money is in the deal, because that is what sets behavior when the business plan slips.

Where do you actually spend your negotiating capital?

dpatel_re · Answer

The acquisition fee, every time, and not because of the dollars. A 2 percent acquisition fee on a deal with thin equity tells me the sponsor needs closing income to fund the shop. That changes how they treat deal selection, because a marginal deal still pays the bills if it closes. I have passed on two raises purely on that read and I have no idea whether I was right, since I didn't get to see the outcomes.

On your math, check what you assumed about the accrued pref. If Sponsor B's pref is cumulative and compounding, and A's is cumulative but simple, your middling case is doing a lot of work that has nothing to do with fees or promote. That one word difference in the LPA moved a comparison I ran last year by more than either fee line did. Worth going back and reading which it is in both.

tylerbrooks9 · Answer

I'd rather have a 1 percent AM fee and a worse split than the other way around, because the AM fee shows up whether the deal works or not, and I can predict it. I know that's the less sophisticated answer.

dmitri_v6 · Answer

vellum, neither of the terms you listed is the one I'd read first. Look at how the AM fee is defined. "1.5 percent of invested equity" and "1.5 percent of gross revenue" and "1.5 percent of assets under management" are three completely different obligations, and on a levered deal the last one can be double the first. I've seen the phrase written loosely enough that the sponsor's own investor relations person couldn't tell me which base they used until she went and asked.

Same with the catch-up in Sponsor B. Does the 50/50 catch-up apply to distributable cash only, or does it also apply to refinance proceeds and sale proceeds? If refi proceeds run through the same waterfall, a sponsor who refis early can get to their promote before the business plan is proven. That is a structural point, and it lives in a definitions section most people skim.

Also confirm whether either agreement lets the GP amend the fee schedule with a majority of LP interests, where the GP's affiliates count toward that majority. That is a real drafting pattern.

mikeoconnell7 · Answer

Reading this from outside the LP seat, the thing that jumps out is that Sponsor A's 2 percent acquisition fee is roughly what a third party would charge to source and close the same asset. So the question is whether they earned it or whether it's just a transfer. If they found the deal off market and closed it in 40 days, I'd pay that. If it came from a broker's blast email, I wouldn't. warrant's point about the AM fee base is the one I'd chase first though, because that's a number you can measure and the sourcing story never is.

Fee load or the promote: which line would you actually fight over

4 replies