This Fund Manager Charges Nothing Until Investors Get Cash
Without a guaranteed yearly cut, the incentive flips from raising ever bigger funds to sharing only real cash payouts.
Joys of Compounding · Brent Beshore - Adventures in Permanent Equity - [Joys of Compounding, EP. 34]Most investment funds that buy companies work the same way. Investors, called limited partners, hand over money. The manager, called the general partner, takes 2% of all the money under management every year, plus 20% of any profit at the end. That 2% arrives whether the investments do well or not.
Brent Beshore, who runs an investment firm called Permanent Equity that buys very small businesses, says that guaranteed 2% is where managers really get rich. If you raise a $100 million starter fund, Brent Beshore says, "Your incentive is to raise $400 million, and then $1 billion, and then $2 billion, and then $5 billion," because you get your cut off the total pile. Returns matter less than growing the pile, and that growth is driven mostly by storytelling and dealmaking.
His firm tries to remove that temptation by charging nothing upfront. It takes no management fees and no reimbursements of any kind, he says, meaning no cash comes from the investors or from the small companies it owns. The firm only gets paid as a share of free cash flow at the same moment cash is sent back to investors.
He calls the test beer money. Unless investors receive cash they could actually walk into a store and buy beer with, the firm charges nothing. Because there is no yearly 2%, its share of those cash payouts is significantly higher than 20%, a number he says he cannot disclose for legal reasons.
He argues the comparison still favors his model once all the other charges are counted. An industry survey lists "106 types of fees that private equity charges," he says, while his firm charges literally one. Two thirds of traditional fees are fixed no matter how the investments perform, he says, and he estimates that "30, 40, even 50% of the returns go to private equity," depending on how you calculate things and on the return profile, situation, and risk preference.
The most interesting consequence is time. With no guaranteed fee to protect and no deadline to raise the next big fund, he says, there is no need to sell a great business early just to show a result. The firm can stay small, buy businesses that earn $2 million to $5 million a year in what he calls "the most inefficient legal market in the world," an off the run corner where skill matters, and let the cash compound.
Questions people ask
Why would a normal fund have to sell a good business early?
In traditional private equity, a fund typically lasts about 10 years. The manager must sell companies and return money within that window in order to show a track record and raise the next, usually larger, fund. That deadline can force a sale of a healthy business at the wrong time.
What are some of those 106 types of private equity fees?
They can include deal fees for buying a company, monitoring fees charged to the companies each year, fees for arranging debt, and charges for expenses like travel and legal work. Beshore argues the problem is that two thirds of traditional fees are fixed no matter how the investments perform.
What happens to this no-fee manager if the investments do poorly?
Then the manager earns little or nothing for that period, since there is no yearly fee and payment only happens when cash is distributed. The manager still owns the businesses and can keep working to improve them, but investors are not being billed while they wait.