The capital stack shows each party’s contribution to the purchase of a property or business, but where do fees fit in?

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What is the Capital Stack

The capital stack is frequently represented by a stacked bar chart showing how each party contributed to the acquisition of a certain deal. On the bottom of the stack, you will see the most senior lender, often a bank loan, or a CMBS loan if it's property. On top of which you may see the junior lender, much like a mezzanine loan. If there is no secondary lien on the property or deal, then you might see a section for preferred stock ownership. Preferred stock is chosen by investors who prefer to be paid before all other equity investors, and they generally enjoy a lower rate of return for their lower risk investment.

On top of that comes the equity portion from the limited partners, and, finally, as the uppermost part of the stack, the equity portion invested by the general partner.

All of these amounts usually sum to the purchase price of the business or property. Hence the stack of capital that demonstrates how debt and equity were used to execute the acquisition. See the below as an example to purchase a $29.3M commercial property:

Capital Stack: Total Value of $29,232,000 comprised of $18,970 from a conventional loan, $4,384,000 from mezzanine financing, $5,584,000 from investors, and $292,000 from the General Partner or Sponsor

Typical Fees in a General Partner/Limited Partner Deal

Another major element in private equity are the fees associated in sourcing the deal and raising the capital. The general partner usually receives these fees, which may include an acquisition fee, closing costs fee, contingency fee, attorneys fees, titling fees, etc. At the back end of a deal when a property or a business is sold, the general partner may or may not also charge a disposition fee.

In respect to the acquisition of a deal however, the fees are often categorized as reimbursement fees to the general partner. Many of these fees represent expenses paid out by the general partner whether in labor, time, or actual line item expenses.

An acquisition fee, consisting of the labor to find, market, present, and underwrite the deal, which may take more than a year of sifting through opportunities, chiefly amounts to 1-1.5% of the purchase price of the deal. Closing costs vary as some general partners lump together the attorney’s fees, titling fees, appraisal fees into the closing costs category. Again these can vary but it is common to see 50k+ in closing cost fees. Contingency fees are more to hedge against unfavorable appraisal amounts, extra attorney’s fees, or other unforeseen expenses. These can vary widely and can range from 10k to 100k or more.

Fees and the Capital Stack

Since fees generally do not equate to equity or debt which directly flow to the purchase of the business or property, they are often excluded from the capital stack. As you can see in the capital stack chart, there were no fees mentioned. The capital stack is designed primarily to delineate which debt and equity sources are used and how much is used to buy into the deal in question. Fees are often treated separately.

Where are Fees Included

The fees need to be clearly defined and described to the investors, and the places to do that officially are in the Operating agreement and the PPM. One method of showing how the fees and how the rest of the capital stack is used is through a table that shows total funds raised and then how those funds are to be employed.

Total Loan of $23,354,000 and Total Capital Commitment from LPs of $6,000,000 for a total source of funds of $29,354,800. The total price of the property, which includes the rolled Acquisition fee) of $29,232,00. In addition to that is the general partner closing costs of $55,000 and a contingency fee of $67,800 for a total use of funds of $29,354,800

Some capital arrangements, like the example above which correlates to the capital stack column chart as well, have the LPs raise their portion of the equity and also raise the portion needed to pay the acquisition fee to the GP of 1%. In this case, the GP rolled over all of their fee as their portion of the equity investment.

Some arrangements have the GP investing their portion (usually 5% to 10% of equity needed) directly from their own funds, and then they retain the acquisition fee of 1% as reimbursement. In the end, it does not matter, from an accounting perspective, whether the GP puts money in first and gets reimbursed or uses the acquisition fee to initially invest, if the amounts are equal. Either way, the GP has their needed percentage invested on the same “side of the table” as the LPs.

Of course there are myriad combinations of GP/LP equity and fees, some do not require that the GP put in any money at all while others require no less than 10% equity from the GP. Each deal is often tailored to the opportunity and the investor’s and GP’s preferences.

Wrap Up

The capital stack is an efficient way to communicate the complexities of purchasing commercial entities or properties. They generally show debt, preferred stock, and equity needed to acquire the deal. Fees are part of what makes deals practical for the GP, and they are usually not included in the capital stack. However, they will be clearly outlined in the Operating Agreement and PPM so that all parties know how the GP will be compensated and how the LPs contribute into that compensation.