Strong Partnership Between Private Equity & Universities
The strong partnership between private equity funds and university endowments was the topic of conversation in today’s Fortune TermSheet.
Fortune TermSheet
By Dan Primack
Friday Feedback
The sky is…
The strong partnership between private equity funds and university endowments was the topic of conversation in today’s Fortune TermSheet.
By Dan Primack
Friday Feedback
The sky is gray, the public markets keep sinking and most people I’ve called this week are on vacation. In other words, it’s time for some Friday Feedback.
Lots of emails yesterday in response to the Yale column, most of which agreed with my criticisms of the NYT piece (perhaps not too surprising, given Term Sheet’s reader demographics).
Peter leads us off: “Your rebuttal was very strong. I also think Victor’s methodology may be incorrect. First off, the 2% management fee is usually only for the investment period and is calculated on committed capital, not NAV. After year 5 it is typically a lower % of cost basis, not committed. I am certain that Victor does not have access to that level of data, so he is probably just calculating 2% of NAV which will inflate the fee paid in a fund with substantial unrealized gains. Also, most buyout funds and some VC funds have to repay management fees and an 8% preferred return on these fees before paying out any carry. In some sense, for strong performing funds, management fees can be thought of as loans to the GP’s that are repaid out of future carry. So again, there is no way that Victor could have access to this level of detail, so is probably again overstating the amount of carry being paid out. He probable just multiplied the % return by the beginning NAV and assumed 20% of that would be carry. As usual, things are far more complicated than that.”
Gary: “Instead of complaining about [PE] fees, the universities should be happy that the PE funds earned so much money that the 20% fees were large. I agree with your logic, although I would like to point out that this approach highlights the importance of setting the hurdle rate high enough so that PE funds are not paid 20% for mediocre investment returns… Another interesting comparison from Yale’s endowment report: In 2014, students paid net tuition, room, and board of $291 million, which is also less than Yale paid in PE fees.”
Frank: “We are all caught up in the arms race of ever more beautiful dorms, lavish cafeterias, $35 million student centers with lap pools and 3-story climbing walls. The better approach would be to have all the top 30 private schools enlarge their incoming freshman classes by 40-50%, something they could easily do without reducing the quality one bit in terms of academic standards. This would help slow the college application frenzy, resulting in 50% more Stanford engineering grads with the resultant impact on startups and job creation.”
Richard: “Nobody is talking about how to reduce the cost of education. So let’s try this, for universities to retain their tax free status they need to freeze student fees and expenses for 5 years. After that, costs to the student will be allowed to increase at the same rate as inflation, which for the last 5 years has been under 2%. Universities have a choice, stay within this cost mandate or give up their tax free status. There will be loopholes in this suggestion, one being cash vs cost accounting. So again to maintain their tax free status universities will have to use GAAP cost accounting just like any corporation so that they cannot financially engineer losses through their tax accounting specialist.”
I also got several emails like this one from (a different) Peter: “You mentioned that you agree with Victor Fleischer in his belief that carried interest should be treated as ordinary income rather than capital gains… As you know, carried interest is earned when private equity firms buy a company, and sell it at a gain. This gain is, by definition, capital appreciation. Capital appreciation is, to my understanding, taxed at a lower rate than ordinary income for two primary reasons: 1) because for a company to appreciate in value it likely had money invested in it that has already been taxed (at either the corporate or individual level), and 2) to encourage capital investment in businesses. Neither of these points is rendered moot because the transaction is being managed by a financial sponsor. Further, I understand that some feel that since the managers of these funds use carried interest as their primary source of income, it should be taxed at the ordinary income rate. To them I ask: ‘what about a retiree whose primary source of income is capital gains and dividend payments? Should he, too, be taxed at the ordinary income rate?’ I would love to hear your thoughts as to why carried interest should be taxed at the ordinary income rate.
