Fee Stack, Valuation Mark-Up and Undisclosed Affiliate Charges
A Category II fund has a corpus of Rs 400 crore. The PPM discloses a 2% annual management fee on committed capital for eight years, including uninvested cash, and a 20% performance fee calculated annually on the scheme's NAV, including upward revisions to unlisted portfolio marks. The manager also causes each portfolio company to pay a 1% 'monitoring fee' to an affiliate; this is not mentioned in the PPM. One portfolio company was marked up 3x after a small primary round led by another fund affiliated with the manager. The valuation was signed off by the manager's CFO, who is not an independent valuer. An LP who is evaluating a secondary sale of its interest asks for the calculation of fees and the valuation basis. The manager says 'the PPM allows us to charge customary fees'.
1. Identify the fee and valuation practices that are inconsistent with the AIF framework and the manager's fiduciary duties.
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The 2% fee on committed capital including uninvested cash is permissible only if it is clearly disclosed and applied exactly as the PPM states. It is not per se illegal, but it creates a drag and must not be supplemented by hidden charges. The performance fee on unrealised NAV is problematic: it rewards mark-ups before cash is received, may breach the PPM if the PPM says realised gains, and creates clawback risk. Good practice and regulatory expectations require performance fees to be based on realised gains, net of costs, preferably with a hurdle and high-water mark. The undisclosed 1% monitoring fee to an affiliate is a conflict and likely a breach of the PPM and fiduciary duty; all fees, whether paid by the fund or by portfolio companies, must be disclosed. The 3x mark-up based on a related-party round is not an independent valuation. The CFO is not independent, and AIF valuation should be done by an independent valuer using recognised methods. The 'customary fees' clause does not authorise undisclosed fees.
2. How should the performance fee and the monitoring fee be treated in the LP's secondary valuation?
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For the secondary valuation, the LP should adjust NAV downward. Remove the 3x mark-up unless it is supported by an independent valuation. Deduct accrued performance fees only on realised gains and only if the PPM permits them. Add back any monitoring fees that should have accrued to the fund rather than the affiliate, or treat them as a conflict and possible recovery. The LP should ask for a fee waterfall showing management fees, expenses, carried interest, and clawback. If the manager has already charged performance fees on unrealised marks, the LP should require a true-up or escrow. The monitoring fee paid to the affiliate may be recoverable for the fund; at minimum, it must be disclosed and consented to. The LP should also check whether the secondary buyer will inherit the fee burden and negotiate a clean-up before pricing the secondary sale.
3. What governance steps should the manager take now?
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The manager should stop charging the undisclosed monitoring fee, disclose it to all LPs, and either terminate it, rebate it to the fund, or obtain informed consent. It should recalculate performance fees on realised gains and establish a clawback or escrow. It should appoint an independent valuer for the portfolio, especially for the related-party round, and document the valuation policy, assumptions, and conflicts. It should constitute an LPAC or independent conflicts committee to review affiliate transactions and valuations. It should correct the PPM for future funds and make a materiality assessment for regulatory disclosure. It should retain counsel and auditors and consider voluntary disclosure to SEBI if there has been a breach. The CFO should not sign off as sole valuer, and the manager should not rely on a general 'customary fees' clause to justify undisclosed affiliate income.