Fund administration fees – How much it costs to launch and run an Alternative Investment Fund

Figure 1: As your AuM grows, fund administration fees as a percentage of AuM fall

Launching an alternative investment fund (“AIF”) takes more than a successful investment strategy. From the outset, you need to consider the fund administration fees, the proper structure and plan for the lifespan of the fund, from concept to realization through eventual liquidation. AIFs are far more complex and require significantly more financial planning than a typical long-short hedge fund.

When considering how much it costs to launch and run an alternative investment fund, it is important to think of every expense that is incurred under a realistic scenario. Want to get a realistic estimate of all fund administration fees? Get in touch with our team of experts to get a personalized proposition that meets your business goals.

What are typical fund administration fees? They cover the provision of services from the following service providers:

  • Licensed AIFM
  • Central Administrator including Transfer Agent and Registrar
  • Depository
  • GP and/or Carry Vehicle(s)
  • Auditor
  • Valuation Agent(s)
  • Fund Board of Directors
  • Placement Agents/Distributors
  • Tax Advisor(s)
  • Lawyers
  • Bank charges
  • Paying Agents
  • Notary

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Fund life cycle

An AIF’s natural life cycle follows these steps:

  1. Legal formation
  2. Raising of capital
  3. Deploying capital to make investments
  4. Managing investments, making follow-on investments, on-going distributions 
  5. Liquidity events – selling off fund’s assets 
  6. Receiving and distributing the proceeds of the sale
  7. Liquidation of the fund

The cycle is generally predicted in advance and incorporated into the Offering Memorandum and other fund formation documents. A typical life might be seven to ten years with longer anticipated duration for funds planning to make regular distributions such as Core Real Estate Funds and shorter duration for those making riskier investments in new ventures. Generally, your fund documents should spell out how long you have to invest (which would typically limit the period during which you could call committed capital) and when you expect to liquidate those investments. At best, the initial estimate of the duration of the fund is just that, an estimate, so provisions should be made for possible extensions to both the investment period and the overall life of the fund.

You also need to cover expenses during that early stretch when you’re still raising capital and income is limited. Otherwise, you could run out of money before your investments have time to succeed. A careful analysis of fund administration fees paired with realistic financial planning of all expenses and sources of capital will prepare you for successfully launching and running your fund. ScalingFunds’ team of experts can help you plan for and launch your next fund

The fund formation documents should take the fund setup expenses into account when describing the sources and uses of funds to be raised. Your investors should be aware that all capital raised will not be invested – expenses will be paid out of capital called/subscribed. Alternatively, some funds include provisions for a separate fee, or add-on capital commitment, to cover ongoing operating expenses.

As you develop your initial financial budget, there are three types of expenses for which you should anticipate and plan: fund setup, fund running and management expenses.

Fund Setup Expenses

Fund setup expenses are the costs to set up an alternative investment fund such as a private equity fund or real estate fund. These include paying for legal services, onboarding investors, opening accounts, coordinating service providers’ setup, tax preparation, notaries and audit.

When you are planning the launch of your fund, keep in mind that many parts of a fund’s setup expenses are similar regardless of fund size. As with fund running fees, many service providers have minimum charges that cover the setup of their function of the fund. These costs can, nevertheless, be highly variable and are impacted by the number and complexity of the target investments, number of investors, the amount and type of leverage used, and the structure chosen. This can put pressure on a startup fund that hasn’t raised much capital. Your fund documents should consider whether these costs will be borne by the fund and its investors or by you, the fund manager. Often a cap on the amount charged to the fund, with the excess paid by the fund manager is the answer.

Fund Administration Fees explained in detail – Running fund administration expenses

Once you’ve estimated how much your fund setup expenses will amount to, you need to think of the fund administration fees, or how much it costs annually to run your alternative investment fund. This is crucial as fund administration fees are a significant part of the management fees you will charge your investors. Failure to properly plan for fund administration fees could leave you in a cash deficit position, or in other words, you won’t be making enough to keep your business operating.

AIFM

Since 2011, the Alternative investment fund managers Directive (AIFMD) governs all managers of alternative investments in the EU. The Alternative Investment Fund Manager (“AIFM”) is responsible for ensuring compliance with the Directive in respect of each AIF it manages, even where such compliance may be outside of its control. Although some of its functions can be delegated, the AIFM is the core part of any alternative investment fund and therefore the first service provider to think of when considering fund administration fees. AIFMs typically have a minimum charge with fees tied to the number of assets, the amount of leverage used, and generally the size and complexity of the assets under management.

Central Administrator

A Central Administrator is typically responsible for many of the back and middle office functions of an alternative investment fund. For example, maintaining the register of investors, capitalization table (if appointed as Registrar), clearing investors (if appointed as Transfer Agent), performing NAV calculations, preparing capital calls and distributions, executing statutory reporting, tax compliance, FATCA/CRS reporting and maintaining fund accounts (in local GAAP or IFRS).

Central Administrators typically have a minimum charge that grows with assets under management, the number of investors, the number of capital calls and distributions, and reporting complexity and frequency.

Depository

The AIFMD (2011/61/EU) Directive requires that authorised alternative investment funds have a depositary appointed to the fund to safekeep the assets of the fund (whether by taking them into custody, or record-keeping and verifying title of them) and to oversee the affairs of the fund to ensure that it complies with obligations outlined in relevant laws and the fund’s constitutional documents. Similar to an AIFM and Central Administrator, a Depository typically has a minimum annual fee that directly scales with the fund’s assets under management.  

Auditor

The AIFMD (2011/61/EU) Directive requires AIFs to have their financial accounts audited on an annual basis. In some cases the fund’s individual assets and transactions need to undergo an audit as well. In top European jurisdictions for funds, including Luxembourg and Ireland, AIFs may choose to file their financial accounts under local GAAP or IFRS. Typically, audits are not a major component of Fund Administration Fees and depend on the size and complexity of the fund – typically lower in umbrella structures.

Corporate Services

There are a plethora of different choices when determining how to structure your fund, and the ultimate choice of structure has an effect on your fund administration fees. Whether your fund is structured as a regulated Luxembourg SICAV-S.A., or a private limited partnership, there are  independent directors that need to be compensated, GP and Carry Vehicles that need to be administered, and domiciliation fees to be paid. Most fund documents include provisions allowing GPs to expense some of their expenses to the fund. Although typically not part of the fund’s administration fees, corporate service expenses are part of your overhead and need to be included in your financial planning. 

Placement agents/Distributors

Fundraising is time consuming and costly for fund managers and increasingly difficult for startup fund managers. Placement agents act as an intermediary between capital seekers, i.e. fund managers, and potential investors, with the primary purpose of bringing the right people from both camps together. Private banks, where the lines between investor and distributor are blurred, are a growing source of capital for alternative investment fund managers that have specific appetites for alternative investments. 

Placement agents are typically compensated for their performance and their fee is paid out by the fund manager’s marketing/setup budget. Even when working with recognized placement agents, be prepared for a significant amount of meetings and specific requests for analysis before garnering interest from investors.

Tax advisor(s) and Lawyers

Successful fund managers will tell you that you don’t want to cheap out on legal fees. You want your fund formation documents to be well thought out as your fund will solely be governed by the articles and provisions in the fund formation documents: the Offering Memorandum and LPA. Having an experienced law firm as a partner with intimate knowledge of the law will provide you with solid ground for negotiations with investors and service providers. The appropriate structure is important to minimize tax leakage, make use of double taxation treaties, while ensuring a sound and secure investment for your investors. Careful planning with the help of a reputable law firm will set you up for success. 

Miscellaneous fees

There are always miscellaneous fees that constitute fund administration fees that need to be factored into your financial planning. They include fund listing fees, regulatory reporting fees, charges incurred to make use of the AIFMD marketing passport in the EEA, notarial fees and paying for the chosen fund management software.

Figure 2: Brickblock’s turnkey solution

In summary, your fund administration fees will grow with the number of investors, complexity and amount of assets under management. 

Salaries and office space – Management expenses 

Historically, a management fee was intended to provide fund managers with enough money to pay modest salaries, rent modest offices and incur modest expenses.  It was said that the management fee was intended to let the fund manager “keep the lights on” and that the performance fee (known as carried interest or carry) was where the fund manager made their money. 

In addition to fund administration fees, there are management expenses you will incur, such as salary expenses and office space you need to rent, that cannot be directly incurred by the fund. The management fee you charge your investors has to cover fund administration fees as well as the management expenses from your fund management company. What expenses are paid by the fund and what expenses are paid by the fund management company are often heavily negotiated terms. Issues such as travel, compliance, administration and other items are negotiated as part of the fund formation documents.

Other Considerations

Since management fees are usually calculated as a percentage of subscribed (or committed) capital during the investment period and then the fund’s invested capital, it may be that your management fees peak during those initial periods when you’re charging on the full amount of subscribed (committed) capital. While this aligns nicely when the expenses of launching the fund front-load your costs, once investments mature and begin to be paid out, your management fees, though not your fund administration fees and management expenses, are likely to decrease. As a result, near liquidation your fund may often be operating at a cash-flow deficit. You should calculate your run rate for setup, administrative and management expenses. Then, subtract that from a conservative estimate of how much you will bring in from management fees based on your expected assets under management. Careful cash-flow management is essential.

Waterfall calculations are often incorporated into fund documents to lay out the priority of payments on liquidity events. The terms may call for reimbursement to the manager for fund administration fees advanced before any distribution to the investors.

As most funds only generate performance fees (carried interest) on the realization of underlying investments (once they are sold off), unless you want to plow your profits back into your operation to fund administration fees, that revenue stream should not be counted on to pay the ongoing bills.

Make sure you have the cash reserves, or sources, to get through the initial setup stages before your fund grows large enough to become self-sufficient and, ultimately, profitable.

Where fund managers get into trouble is by having overly optimistic views for the first years, both in terms of expecting lower costs and predicting that they will raise capital quickly. For your financial budgeting, take a conservative view. If you raise half of what you’re targeting, can you still cover all your expenses?

By answering these questions before you launch, you can anticipate and budget for these costs until your new fund begins to bear fruit.

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