In the previous post, it was noted that profits for a private equity fund can be based on an aggregate level or individual transactions. Let's take a quick look at a simplified calculation, using round numbers, to compare the methodologies. For a fund, the manager has invested $150 million in two portfolio companies. The first company was bought for $100 million and sold for $120 million. The second company was bought for $50 million and sold for $30 million. For this exercise, the hurdle rate is 10% and there is no clawback option.
If you total all the numbers, $150 million were invested and $150 million were realized. There was no gain on the investments and the manager would not receive an incentive fee.
If you look at each investment separately, the first investment would have a return of 20%. This triggers the performance fee calculation of $20 million x 20% = $4 million. The second company has a return of -40% and would not trigger any incentive fees. The fund manager would still receive $4 million.
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