Same Fund, Same Fee, Different Base
The fund is the base case of the default-timing study: a $100 million direct-lending fund that originates sixteen equal four-year loans, one a quarter, at a 10% cash coupon, with a 1.25% management fee, 10% carried interest over a 7% preferred return with a full catch-up, and no defaults. This note isolates one clause of that fund's terms, the base the 1.25% is charged on, and measures its effect on the LP's return with every other term fixed. The clause is worth up to $4.9 million of the LP's cash on a $100 million commitment, a seventh of the LP's net return, and it is the one term in the table that the LP can negotiate.
Three readings of the same fee
Private-markets fee clauses come in three common forms. The fee can be charged on invested capital throughout, which is the market norm in direct lending. It can be charged on committed capital during the investment period and invested capital after, which is the buyout convention and is often imported into credit documents unchanged. Or it can be charged on committed capital throughout. All three appear as a 1.25% management fee in the fund summary.
| Fee base | LP net IRR | LP net multiple | Management fees over the fund's life | Fee in year one | LP distributions received by end of year 4 |
|---|---|---|---|---|---|
| Invested capital throughout | 8.19% | 1.29x | $4.7M | $0.1M | $17.5M |
| Committed during the investment period, invested after | 7.28% | 1.26x | $7.2M | $1.2M | $17.0M |
| Committed capital throughout | 6.97% | 1.24x | $9.8M | $1.2M | $16.5M |
The fund's loans, coupon, carry terms and drawdown schedule are identical in every row. The 122 basis points between the first and third rows, and the 91 basis points between the first and second, come from the base alone.
What the clause is worth
On the same $100 million commitment, the LP pays in about $98.6 million under every base and receives $127.5 million back under the invested basis, $124.3 million under the buyout convention, and $122.6 million under the committed basis. The committed basis takes $4.9 million of cash and 17% of the LP's profit; the buyout convention, the form most commonly encountered, takes $3.2 million and 11%. Lifetime management fees rise from $4.7 million to $9.8 million, more than double, with no change in what the fund does.
Three comparisons place the figure. Against the fund's own return, 122 basis points on a fund earning about 8% net is a seventh of the return, and it moves the LP's net IRR from above to below the fund's own 7% preferred-return rate. Against the other effects measured on this identical fund, the whole default-timing effect was 40 to 60 basis points of IRR and the catch-up-band effect 35; the fee base is worth two to three times either. Against a program, a $1 billion credit allocation documented on the committed basis carries on the order of $50 million of lifetime fees that the invested basis would not have charged. The default-timing and catch-up effects are set by the loan book and the waterfall. The fee base is set by a clause.
Why the clause costs more than it reads
The mechanism is the same one that makes committed capital different from invested capital. In the first year the fund has drawn roughly a quarter of its commitments. A fee on invested capital is levied on that quarter: about $0.1 million. A fee on committed capital is levied on the full $100 million: about $1.2 million, twelve times the invested-basis fee, charged before the portfolio earns a full coupon. The gap narrows every quarter as the fund draws down, and by the end of the investment period the two bases converge. The early cash flows already carry the cost, which is where IRR is most sensitive, and the LP's net multiple carries the cumulative fee difference to the end.
The middle row is the form most commonly encountered. The buyout convention charges on committed capital while the fund invests and steps down to invested capital afterwards. In a credit fund that draws over four years, that convention costs the LP about 90 basis points of net IRR against the direct-lending norm. The difference is structural and independent of manager selection.
What the LP should do
Diligence the fee base, not only the rate. The summary page says 1.25%. The clause says what the 1.25% is multiplied by, and that is the number that moves the return. Treat the fee basis as a term to be diligenced on the same footing as the hurdle and the catch-up.
Model the fee against the fund's own drawdown pace. A diligence model that applies the headline fee to the headline commitment on a straight-line schedule gets all three bases wrong, in different directions. The fee has to be computed month by month against the capital drawn under the fund's realistic deployment schedule, because the whole effect lives in the early years.
Ask the manager which convention the document uses and why. In direct lending, a fee on committed capital throughout is unusual enough to warrant an explanation. A buyout-style step-down imported into a credit document is common enough that its cost on the fund's own numbers belongs in the diligence memo.
Assumptions
Market-typical senior direct-lending terms, chosen for the default-timing study and unchanged here: $100 million of commitments with a 1.5% GP commitment, sixteen equal loans originated one per quarter over a four-year investment period, 48-month bullet loans at a 10% cash coupon with a 2% closing fee, a 1.25% management fee during and after the investment period, 10% carried interest over a 7% preferred return with a full catch-up, $750,000 of organizational cost, and no defaults. The three fee-base rows were produced by the same loan-level model, with the fee base as the only input changed. Figures are model outputs on illustrative assumptions, not a forecast for any fund.