If you have decided to start a private equity fund, hopefully you have taken some time to consider how you will be compensated for managing the fund and making successful investments.

Following are some of the more common fee structures used by sponsors of private equity funds:

• Management fee: The management fee is commonly charged as a percentage of assets under management, and is usually between 0.5% and 2%. First-time hedge fund managers usually try to minimize or eliminate the management fee in order to align their interests with those of the fund investors.

• Performance fee/carried interest: Private equity fund sponsors often receive a performance fee that is calculated as a percentage of the fund’s profits or gains. The manner in which the fee is calculated and the frequency in which it is paid depends on the fund’s underlying assets. If the fund’s underlying investments are expected to pay significant dividends, then the general partner of the fund may be paid a performance fee at the same time that the dividends are paid. More commonly, the performance fee is paid when the fund’s underlying assets are sold. The amount of the performance fee is usually at least 20%, and can be greater if no management fee (or a low management fee) is charged. The performance fee is usually paid as a “carried interest” in the fund, which permits the general partner to pay capital gains tax rates on the carried interest, rather than at ordinary income rates.

• “Waterfall” fee: In a waterfall structure, the investors in the fund receive their initial investment back first (plus sometimes, a stated rate of return) before any fees are paid to the general partner. An example of this would be the investors receiving 125% of their capital contributions, then an allocation to the general partner of 20% of the amount of any gain. Any remaining gain is then allocated to the investors.

Note that the ability to charge a performance fee depends on the state in which the general partner is located, if your private equity fund has less than $150 million in assets under management. For funds smaller than this amount, it may not be permissible to charge a performance fee to investors that are not considered “qualified clients” under SEC standards.

There are many important legal issues to be considered when forming a private equity fund, including the fee structure. If you are ready to form your private equity fund, contact Whitley LLP Attorneys at Law today. We can help you navigate the complex legal issues involved and help your fund get off to a successful start.