Private Equity Not So Private: Blackstone, TPG Reveal Fees

Jan 2 2015 | 5:58am ET

By Sabrina Willmer and Alan Katz (Bloomberg) -- Two of the biggest private-equity firms are disclosing fees that had largely been hidden as U.S. regulators demand increased transparency from the industry.

Blackstone Group LP said it could collect as much as $20 million annually from investors and companies in its next buyout fund, for services such as health care consulting and bulk purchasing. TPG Capital put the potential charge for similar services at as much as $10 million a year for its new fund, which is currently seeking to raise as much as $10 billion.

The fees, detailed in recent marketing materials obtained by Bloomberg News, are on top of other monitoring and transaction fees and haven’t been disclosed in such detail in documents governing earlier funds. The U.S. Securities and Exchange Commission has criticized the industry for passing on charges to clients without their knowledge, and is trying to persuade the $3.5 trillion private-equity industry to improve disclosure.

“We’ve entered a new day,” said David Fann, chief executive officer of TorreyCove Capital Partners, which advises pension plans on private equity investments. “Most investors will request more robust disclosure surrounding fees being paid by portfolio companies to private equity funds.”

Buying Companies

Private equity firms buy companies using a combination of investor capital and debt, with the goal of selling them or taking them public for a profit. They typically charge annual management fees of 1.5 percent to 2 percent of committed funds and keep 20 percent of profits from investments. Buyout firms also charge the businesses for buying, selling and monitoring them, though firms have increasingly passed on these expenses to investors in the funds by reducing the management fee.

The fees questioned by regulators are for services provided by consultants, known as operating partners, who are paid by private equity firms for their expertise on various aspects of running a business including recruitment, procurement of goods and pricing strategy.

In a May speech, Andrew Bowden, head of the SEC’s inspections office, said he was concerned about improper fees and the allocation of expenses to investors that should be paid by the firms. He said more than half of the private equity firms examined to that point were either breaking the law or had “material weaknesses” in controls.

Common Deficiencies

One of the most common deficiencies found was the funds’ failure to tell investors about how operating partners were compensated and how those levies weren’t used to pay the management fee. Most limited partnership agreements require that fees produced by employees or affiliates of the private equity firm offset the management fee, Bowden said.

“Operating partners, however, are not usually treated as employees or affiliates of the manager, and the fees they receive rarely offset the management fees, even though in many cases the operating partners walk, talk, act and look like employees or affiliates,” Bowden said.

The SEC has backed Bowden’s tough talk with enforcement actions. In October, the agency fined Clean Energy Capital and its founder Scott Brittenham for misallocating funds and changing distribution calculations without adequate disclosure. Clean Energy didn’t admit or deny the SEC’s findings in the settlement.

‘Behind Us’

“We’re happy to get this behind us,” said Aegis Frumento, a partner at Stern Tannenbaum & Bell LLP in New York, who represents Brittenham and the firm.

In September, the SEC fined Lincolnshire Management $2.3 million for sharing expenses between portfolio companies in a way that benefited one fund over another. Lincolnshire, a New York-based private-equity firm, didn’t admit or deny the SEC’s allegations.

Robert Pommer III, a lawyer for Lincolnshire with Kirkland & Ellis LLP in Washington, didn’t reply to a voice-mail or e- mail for comment.

Many buyout firms, including KKR & Co, TPG and Blackstone, use consultants to help improve companies they own. TPG uses an in-house operations group of 47 professionals that offer advice. Blackstone’s portfolio operations group works with chief executive officers of companies the firm owns.

Prior Funds

In its recent marketing document, Blackstone disclosed some fees that weren’t listed under the prior fund’s limited partnership agreement, including those related to health-care consulting and group purchasing. These fees will also be subject to the $20 million cap, according to the document.

TPG has also increased transparency on fees it charges investors for services including information technology, public and government relations work, property management and customer service, according to the marketing document for its latest fund.

Peter Rose, a spokesman for Blackstone, declined to comment. Owen Blicksilver, a spokesman for Fort Worth, Texas- based TPG with Blicksilver Public Relations, declined to comment.

The hidden fees for services aren’t the only ones under SEC scrutiny. The regulator is also looking at accelerated- monitoring fees, which are lump-sum payments for future services that haven’t been provided, which private equity firms would otherwise lose when selling businesses. Private equity firms have taken in more than $1 billion in such fees from companies they’ve taken public since 2010, according to data compiled by Bloomberg.

Blackstone recently ceased taking these payments, a person with knowledge of the matter said in October. Blackstone took $46.3 million in these fees when it listed SeaWorld Entertainment Inc. last year and $26.2 million from pharmaceutical company Catalent Inc. this year. TPG provided additional disclosure in the marketing document for its latest buyout fund that it would receive such fees from companies, which “may be significant.”

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