Why acquisition fees in a syndication matter
Fees aren't everything, but they shouldn't be ignored
First and foremost, welcome!
I appreciate you signing up and hope you get a lot out of these.
First, some background:
An acquisition fee is typically a fee that is charged by a GP for putting together a transaction.
Most acquisition fees are charged based on Purchase Price, but don’t forget to ask and check your documents as this varies across both GPs and deals
GPs put time and effort into chasing a deal and finding an attractive one, so it makes sense to pay them a fee to compensate them for that effort.
There are two questions to answer about acquisition fees:
How much should the acquisition fee be? How much is too much?
Why does the fee matter, and how does it impact me as an LP?
Today, I want to touch on the second point - how to think of the fee, in the context of being an LP. I will touch on the first soon for paid subscribers.
Below is a simple table that illustrates the fact that when an LP pays a fee up front, you are immediately down on (i.e. have lost a part of) your invested equity.
As a result, the investment needs to make up for this to “get you out” of the hole. This is sometimes referred to as a drag on your returns, and as you can see, the drag is very real.
Below is the -24% with an actual example, so you can see the math.
I hope this gives you an initial view of why acquisition fees impact you as an LP.
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In this example of $1,000 purchase price, assuming the GP is distributing a 5% cash on cash throughout a 5 year hold, then my equity is slightly above 1. Is that correct? The hole was -24% vs 25% (5% * 5 years).