Fund Level Expenses - Making Sense of Allocation Methodologies

19th November 2019

Recently, we have noticed an increase in the number of clients reaching out to discuss the proper allocation of expenses down to the investment Funds they manage. This is a growing concern in the United States, particularly within the illiquid Funds space (e.g., Private Equity, Real Estate, Venture Capital, Credit, etc.), given there is less regulatory guidance as compared to many other types of Funds. 

To provide a brief background, the discussion regarding which expenses should be borne by the Funds (and ultimately the investors) and which expenses should be borne by the Management Company (and ultimately the Fund Manager) has been an actively debated topic for many years.  However, Fund Managers are directing far more attention to the topic now, than in the past.

It should also be noted that the United States Securities and Exchange Commission (“SEC”) has been focusing more of its efforts, on this particular topic, over the last couple years.  This, of course, explains the increased focus of Fund Managers, most of whom are registered with the SEC.

There are a few items that are universally accepted as expenses borne by a Fund.  Examples include fund administration, audit, tax, syndication costs and legal fees pertaining to the organization of a Fund.  However, there are numerous other expenses, for which the ability to allocate to a Fund is not quite as clear.  Examples include, certain marketing, travel, and due diligence expenses, just to name a few.  Within these categories, there are often items that are acceptable Fund-based expenses, however not all items may qualify, and the determination of which items are to be allocated to a Fund can take a bit of deliberation. 

We genuinely believe that everyone involved is trying to do what is most appropriate, which is why there has been so much discussion, and why we have seen such an increase in questions from clients, and others within the industry.  That said, there still seems to be a lack of clarity and consistency.

As such, we wanted to share a few “best practices”, that we have seen effectively utilized among many of our clients, in order to help manage the potential challenges noted above.

  • Legal Documents – the best way to get ahead of the complicated questions pertaining to proper expense allocations is to work with your legal counsel during the fund formation process to include as much specific language as possible regarding expense allocations.  Additionally, it’s worth having early conversations with your fund administrator around common pitfalls and grey areas in order to ensure the legal documents are addressing relevant scenarios (we often work quite closely with our clients and their legal counsel during the fundraising process).
  • Consistency – once an internal approach has been adopted, it’s important to apply it consistently, particularly within a specific Fund.  To revise an allocation policy when launching a new fund is not uncommon, but it is better not to retroactively apply a new policy to an older Fund.  
  • Transparency – proper financial reporting of expenses is crucial (although, as fund administrators, we are biased here).  The financial reporting of a Fund is a crucial component to clearly communicate to investors what expenses are being paid by them (via the Fund).  

Langham Hall is an award winning provider of Fund Administration, Depositary and AIFMD services to global fund managers. Please do contact us if you would like to discuss this topic further.