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Tax News
Private Equity Management Fee Waivers – the Latest by Andy Grewal, Gregg Polsky and Others
February 04, 2015
Miscellaneous
This is not breaking news, but in light of the supposedly upcoming guidance regarding management fee waivers, we wanted to write a short bit about the status quo. We also want to highlight an article by Andy Grewal, which we thought did not get sufficient exposure commensurate with its quality.  First a short description of what a fee waiver/conversion is. In a private equity fund the typical compensation structure is “two and twenty.” The twenty could be held by the same entity or a different entity from the one that holds the “two.” The “two” reflects fees for management services, like portfolio management and the “twenty” reflects carried interest/profits interest, which is paid as incentive compensation to the GP of the private equity fund. Some fund managers decide that they want to waive the “two” or a portion of the “two” in exchange for an increased “twenty.” There are various drafting approaches and mechanics of implementing this, but generally they involve baking in the private equity fund LP agreement some waiver language and a commensurate change in the waterfall and allocation provisions. The waiver could be hardwired as of day one without subject to change or it could be optional as of “X” days from the end of each fiscal year.

This private equity fund practice has caused a rather notable volume of professorial and tax practitioner writings. Who is right and who is wrong we would not debate here but we want to highlight the course that this debate has taken and the key players. To look back to where it all started, one would say that Gregg Polsky could be credited with stirring the pot with his article “Private Equity Management Fee Conversions” which was published on TNT in 2009. This piece probably earned Mr. Polsky as much notoriety in the investment fund industry as Mr. Fleischer’s “two and twenty” earned him in 2008. Then the baton was taken by Lee Sheppard with “Why Are Fee Waivers Like Deep-Fried Twinkies” and by Mr. Fleischer himself with a short bit “What’s at Issue in the Private Equity Tax Inquiry” and then the “Top 10 Private Equity Loopholes.” Finally, Mr. Polsky again, this time in 2014 came up with another article, “A Compendium of Private Equity Tax Games.”  All of these, you would guess, tell us why fee waivers do not work. Also, in essence they proffer that the industry enjoys the benefits of “loopholes” that other hard working Americans do not get.  As it may be, we are far from attempting to make political or policy statements here. As they say, it’s above our paygrade. The powers at be on the Hill need to solve this, if there is anything to solve in the first place. However, we wanted to put up a link to an article by Mr. Grewal that was not featured on TNT. The article titled "Mixing Management Fee Waivers with Mayo" explains that under the current status of the law, the waivers actually present a cogent position. Here is a link to the article. In all fairness of course, here are link1 and link2 to Mr. Polsky’s articles as well. Enjoy, if you have not read those yet. Hopefully this issue will be put to bed by the end of this year, assuming Treasury actually gets to it as per its annual priority issues list.
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