0

I'm trying to understand why private equity tends to have higher fee structures than public markets. My hunch is that it takes more skill/risk to manage illiquid assets. I'd also imagine more due diligence is required in PE. However I'm not sure I've hit the main vein of logic behind it all.

Question

Why does private equity have a higher fee structure than public markets? If I was on the right track with my above observations, feel free to elaborate; otherwise feel free to add/remove what doesn't work.

Improve this question

1 Answer 1

Reset to default
2

Like hedge funds, private equity funds charge high management fees as there is potential for strong gains, but it's also high risk. If private equity investors find an existing company that they believe is underperforming and they buy it with the intention of turning it around, there is a lot of risk involved with this (and yes, research and due diligence). They might not truly understand the company's problems until they buy it and look under the hood.

It might seem like it is just a matter of firing incompetent old executives who are making poor, outdated decisions and don't have the innovation or insight to grow the company, or cutting out a whole lot of dead wood and replacing employees with automation, or outsourcing certain parts of the company to decrease expenses. But there could be so much more to it than this. It could be a total lemon and require a lot more work, coaching and management than they expected. What if all the employees are so demotivated the private equity investors have to completely restructure the whole company and pay out redundancy pay to a lot of people?

They have to charge high fees for all the work they put in before they can wrap the company up in shiny new wrapping paper and sell it on for a big profit (hopefully) for their investors.

Improve this answer
2
  • 2
    "that they believe is underperforming" One of the problems with PE is that a company can be "ticking over" quite happily making steady, but not spectacular returns (by PE standards), with competent executives and motivated employees. A PE firm swoops it up, tries to "modernise the board and cut out the deadwood" but leaves behind executives with no real understanding of the business and a now-demotivated workforce.
    – TripeHound
    Feb 24, 2020 at 10:01
  • Absolutely - there are a lot of PE critics out there who believe PE guts a company and destroys it before selling it on. But there are also a lot of investors who jump at the chance to buy stocks in the shiny new rebranded company, and so the PE cycle continues...
    – Only_me
    Feb 24, 2020 at 23:58

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .